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Earnings on track after two quarters of setbacks

Core NIM rises ~10bp QoQ; provision release from ECL model refresh

* Mahindra & Mahindra Financial (MMFS)’s 3QFY24 PAT declined ~12% YoY and grew 135% QoQ to ~INR5.5b (in line), while 9MFY24 PAT declined 12% YoY to ~INR11.4b. Net Total Income (NII + Fee income) rose ~10% YoY to INR18.2b (in line), while PPoP grew ~6% YoY to ~INR10.6b (in line).

* Credit costs declined to ~1.4% (PQ: 2.8% and PY: 0.8%) and included writeoffs of ~INR4.5b (PQ: ~INR3.5b). The total ECL provisions release of ~INR1.2b included the benefit of ~INR860m released from the ECL model refresh.

* MMFS reported a core NIM expansion of ~10bp QoQ. Including noninterest income, NIM (as a % of assets) expanded ~30bp QoQ to 6.8%.

* After two prior quarters of volatility, MMFS has delivered an earnings performance where most of the monitorables were in line except for the elevated levels of write-offs. We expect the NIM improvement to sustain and credit costs to further decline in 4QFY24. We model an 18%/20% CAGR in AUM/PAT over FY23-FY26E, with an FY26E RoA/RoE of 2.4%/17%. Reiterate BUY with a revised TP of INR340 (based on 2x FY26E BVPS).

* Key risks: a) muted yields because of higher competitive intensity and increasing proportion of prime customers, b) PCR on S2 and S3 staying elevated longer than expected because of the intricacies of the ECL model.

NIM expansion led by improvement in yields and lower negative carry

* NIMs improved ~10bp QoQ to ~7.1% aided by ~15bp rise in yields. Also, there was a healthy improvement in the fee income (non-lumpy), which is expected to sustain. MMFS also calibrated the liquidity on its balance sheet to reduce the negative carry from the liquidity buffer.

* A marginal interest rate hike of ~20bp and conversion of trade advances into retail customer loans also aided yield improvement in 3QFY24.

* Borrowing costs rose ~15bp QoQ to ~7.8%, and incremental CoF stood at ~8%. Management guided that it expects the incremental CoF to remain stable even in 4QFY24. We estimate NIM to moderate to ~7.2% in FY24 (vs. 8.3% in FY23) and then expand to 7.4%/7.5% in FY25/FY26.

Key takeaways from the management commentary

* Structural changes at MMFS will help it avoid the volatility that it exhibited in the past. It has reduced its participation in highly volatile customer cohorts. Management guided for much lower volatility even when the current benign credit cycle gets adverse.

* Management is cognizant of what should be the ideal level of prime customer sourcing to protect its NIM profile.

Valuation and View

* MMFS is still going through a transformation in its product/customer mix, and its NIM profile will change as it finds its new sustainable normal. It will hopefully now start demonstrating more predictability in its earnings performance. A strong liability franchise and deep moats in rural/semi-urban customer segments position MMFS well to reap the rewards of the hard work that is going into evolving this franchise.

* MMFS currently trades at 1.6x FY26E P/BV. The risk-reward is favorable for a PAT CAGR of ~20% over FY23-FY26E and FY26E RoA/RoE of 2.4%/17%. Reiterate BUY with a revised TP of INR340 (based on 2.0x FY26E BVPS).

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