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Asset-quality concerns remain the focal point

* Mahindra Finance (MMFS) reported Q1FY23 earnings of Rs2.2bn, below our estimate of Rs5bn. Considering the implementation of RBI’s new NPA regime from October 1, 2022, operating expense and credit costs would remain elevated on account of intensified recovery/resolution efforts along with investment in new product segments. During the quarter, disbursements grew by 3% qoq/145% yoy, driven by growth in tractors, utility vehicles, and cars, resulting in AUM growth of 4% qoq/5% yoy. NIMs for the quarter increased by 18bps qoq, with cost of funds yet to reflect the impact of the prevalent higher market interest rates. Cost-to-income ratio for the quarter was 39.6% (Q4FY22: 41.3%). As a result, pre-provision operating profit growth was 5% qoq/26% yoy. Credit costs for the quarter were elevated at 3.2% (Q4FY22: 0.3%) due to termination losses and aggressive repossessions. In line with seasonal trends, asset quality remained weak with GS3 at ~8% (Q4FY22: 7.7%) and NS3 at ~3.5% (Q4FY22: 3.4%). Restructured book stood at Rs36bn (5.3% of business assets) vs. Rs40.2bn (6% of business assets) as of Q4FY22. The trend of improvement in stage 2 loan ratio continued, reflecting efforts of management to stem the forward flows into stage 3 bucket. Management does not anticipate any need for substantially large provision in Q2FY23 to bring NNPA ratio below RBI’s threshold of 6%

* MMFS seeks to leverage the ‘Mahindra’ ecosystem by providing finance, investment, and insurance solutions in rural and semi-urban markets. It primarily finances new and preowned auto/utility vehicles, tractors, cars, and commercial vehicles. MMFS is a play on the burgeoning credit demand of underserved rural/semi-urban India.

* We retain our Hold rating on the stock with a revised Sep’23E TP of Rs210, valuing the firm at 1.3x Sep’24E BVPS, using the excess return on equity method (ERE) for FY23E24E RoE of ~12%. Elevated stress on the balance sheet presents downside risk to our valuation. Upside risks include faster-than-expected pick-up in growth and minimal impact of shift to new IRAC norms.

* Q1 result highlights: For Q1FY23, MMFS’s total disbursements stood at ~Rs95bn (+3% qoq/145% yoy), primarily led by tractors (+34%), cars (+9%), and utility vehicles (+6%). Disbursement share of tractors, utility vehicles, and cars increased, whereas that of CV and CE and pre-owned vehicles declined. As a result, AUM grew by 4% qoq/5% yoy. NIMs increased by 18bps qoq/183bps yoy to ~7.4% due to a 15bps sequential decline in CoFs. Cost-to-income ratio declined by 171bps qoq to 39.6% (Q4: 41.3%), resulting in PPOP growth of 5% qoq/26% to Rs9.5bn. Termination losses and aggressive repossessions led to provisions of Rs6.4bn (Q4: 0.6bn), resulting in a sharp increase in annualized credit costs to 3.2% (Q4: 0.3%). In line with seasonal trends, asset quality remained weak with GS3 at 8% (Q4: 7.7%) and NS3 at 3.5% (Q4: 3.4%). PCR remained stable at 58.1%. Restructured book stands at Rs36bn (5.3% of business assets) as of Q1FY23 vs. Rs40.2bn (6.2% of business assets) as of Q4FY22.

* Management has guided for the following: 1) PCR will be maintained at ~58%, 2) Credit costs are likely to decline by at least 1% from current levels on the belief that aggressive repossessions would no longer be needed, 3) A possible 50-60bps rise in CoFs, assuming a 50-70bps hike in repo rate from current levels, 4) Opex-to-AUM likely to remain elevated at 3% for FY23.

* Changes in estimates: We have trimmed our FY23 AUM estimates to reflect the impact of recent write-offs and increased focus on recoveries. Thus, we estimate FY23E AUM growth to be 12.7% vs. earlier estimate of 14.1%. We have factored in the increasing interest rate environment for the forecast period and marginally trimmed our NIM estimates over FY23E25E. Considering the start of the new NPA regime from October 2022, we have increased our operating cost estimate for H1FY23 to factor in the higher recovery/resolution related costs. We estimate FY23E operating expense as a % of average assets to increase to 3% vs. our earlier estimate of 2.9%. We have increased credit cost estimate for FY23 to 2.5% from the earlier estimate of 2.0%.

* Valuation: We retain our Hold rating on the stock with a revised Sep’23E TP of Rs210, valuing the firm at 1.3x Sep’24E BVPS, using the excess return on equity method (ERE) for FY23E24E RoE of ~12%. Elevated stress on the balance sheet presents downside risk to our valuation. Upside risks include a faster-than-expected pick-up in growth and minimal impact of shift to new IRAC norms.

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