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Strengthening its core to drive efficiencies and reap rewards

Expect volatility in profitability and credit costs to decline meaningfully

Mahindra Finance (MMFS) has demonstrated utmost seriousness in overcoming its weaknesses that led to a lot of volatility in its reported margins, asset quality and credit costs. MMFS has also embarked on a few other strategic initiatives, which will help it: a) improve productivity, bring efficiencies and reduce the operating cost ratios, b) target the affluent rural and semi-urban (RUSU) customer segment with relevant lifecycle products, and c) leverage analytics and business intelligence to mitigate various risks and improve both business volumes as well as collections. We believe that MMFS will benefit from its parent Mahindra & Mahindra (M&M)’s strong recovery in auto volumes. We model an AUM/ PAT CAGR of 13%/27% over FY22- FY24E for an RoA/RoE of 1.8%/9.6% in FY24E, respectively. We recently included MMFS in our model portfolio. We retain our BUY rating on the stock with a TP of INR235 (premised on 1.7x FY24E P/BV). Key risk to our call: potential volatility in asset quality and credit costs after the implementation of the RBI NPA circular from Oct’22 onwards.

Better volumes from M&M can support loan growth of MMFS

Wholesale volumes of M&M during Apr-Jun’22 surpassed our estimate, with a healthy improvement in UVs (including Pickups), even though the tractor volumes were slightly subdued. We estimate MM’s Automotive segment to deliver ~40% growth in volumes in FY23. The contribution of M&M’s assets to MMFS’ AUM stood at 46% in Mar’22 (up from 43% in Mar’19). We expect MMFS to benefit from the projected higher volumes of M&M, particularly in the UV segment, which has always been the former’s strength.

Vision 2025 could appear aspirational but it is a step in the right direction

Vision 2025 articulated its ambitious goals of improvements in AUM, asset quality, NIM, cost ratios, and RoA. While the growth targets (doubling AUM in 3-4 years) appear aggressive, it will keep pushing the management team to deliver a much improved performance. What is even better is that the parent is now taking a more prominent and explicit interest in MMFS’ performance.

Multiple recent initiatives have the potential to transform this franchise

To translate its Vision 2025 ambitions into reality, MMFS has introduced multiple initiatives and formulated goals to firmly secure some of the articulated targets. These include: a) scaling newer growth engines; b) changing customer segment mix; c) product diversifications; d) collection war-rooms and legal efforts; e) leveraging AI/ML models by hiring quality tech and data science teams; and f) empowering employees with the latest technology to improve productivity and drive process optimization.

Healthy monsoons can lead to recovery in the fortunes of rural India

Monsoons, this year, which were in deficit until 5th Jul’22 have swiftly recovered and India had a 13% surplus as on 17th Jul’22. In the backdrop of expected healthy monsoons, the farm cash flows can improve leading to rural recovery and resulting in higher volumes. After a lull in FY21 disbursement, followed by the second Covid wave in India, MMFS has now pressed the accelerator on disbursements. Rural recovery will aid disbursement volumes, which combined with the increase in ticket sizes of vehicles can help MMFS deliver healthy disbursement/AUM CAGR of 25%/13% over FY22-FY24E, respectively.

MMFS is relatively less susceptible in a rising interest rate environment

Around 75% of its liabilities are at a fixed rate, while almost all of its AUM is at a fixed rate. While MMFS will be relatively less susceptible on the borrowing side, it will have limited headroom to pass on the higher cost of borrowings to its customers, leading to a compression in spreads in FY23E. We model in a NIM compression of ~30bp/20bp to 8.3%/8.1% in FY23E/FY24E, respectively.

Healthy and well-diversified liability franchise will keep MMFS in a good stead

MMFS has a credit rating of AAA from India Ratings and CARE while it has an AA+/Stable rating from CRISIL. A big enabler underlying this credit rating is the strong parentage of M&M, which we believe is now taking a very prominent and explicit interest in the performance of MMFS. The company has maintained a liquidity buffer of greater than three months all through and has a very healthy ALM profile with a positive mismatch across all the buckets/tenures.

Asset quality and credit costs volatile in the past but likely to offer more stability going ahead

During the second Covid wave, the stress build-up was more pronounced for MMFS relative to its peers such as CIFC and SHTF. MMFS did, however, end up reversing all ECL provisions of ~INR25b that it made in 1QFY22 for the next three quarters. But this came along with associated equivalent write-offs of ~INR25b in FY22. Under Vision 2025, MMFS endeavors to deliver a stable asset quality, with GS3 below 6% across the credit and economic cycles. Stability in credit costs, however, is even more desirable. We believe that MMFS is already taking steps in that direction and we model credit costs of ~2.6% in FY23-FY24E (v/s 3.7%/5.6%/3.1% in FY22/FY21/FY20, respectively).

Poised for growth; a strategic transformation on the cards – Maintain BUY

Though still in nascent stages, both the small ticket lending business (Digi Finco) and the vehicle leasing and subscription business (Quiklyz) hold a lot of promise for MMFS. The company has managed to maintain its leadership position in the Tractor and Mahindra UV financing segments, which has always been its strength. While understandably, the company has exhibited volatile operating performance and weak asset quality in the past, we believe that the various strategic initiatives undertaken by the management, if executed correctly, have the potential to script a credible transformation. Strong liability franchise and deep moats in rural/semiurban customer segment position MMFS well to reap rewards of the hard work that is going into evolving this franchise. We maintain our BUY rating on the stock with a TP of INR235 (premised on 1.7x FY24E P/BV).

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