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A disappointing show

Multiple disappointments in sharp NIM decline, elevated opex and much higher credit cost

Bereft of any one-offs, MMFS delivered 5%/11%/55% miss on NII/PPOP/PAT in Q2 FY24. While the headline growth and asset quality trends were known, the substantial miss on earnings was driven by steeper-than-expected 30 bps margin contraction (led by decline in portfolio yield), high opex (required strategic investments) and significantly large credit cost (caused by meaningful slippages, material write-offs and high LGD). Management alluded to some weakness in collections during later part of September leading to significant flows from Stage-2 into Stage-3 (particularly in tractor finance portfolio). Loan write-offs remain significant in the context of the opening book and GNPLs.

Management expects 20%+ growth, margin recovery and much lower provisions in H2 FY24

Encouraging festive sales, strong rural cash flows, stable market share and diversified product portfolio underpins management’s expectation of delivering 20%+ growth in the year. Unlike the first half, the portfolio mix is expected to shift towards higher yielding products of pre-owned vehicles (eased availability of vehicles) and tractor financing. NIM has been guided to recover from current 6.5% to 6.8% by Q4 FY24 aided by 1) planned lending rate hikes, 2) growth pick-up in higher yielding products and 3) conversion of interest-free trade advances (worth ~Rs50bn) into retail loans. Co. would be contemplating raising lending rates for select products and models after Diwali. Management expects credit cost for the year to be 1.5-1.7% (2.6% in H1) with significant reduction expected in Stage-3 assets through collections. The level of writeoffs is expected to moderate in coming quarters.

Earnings undergo material cut; valuation to be impacted too - downgrade to NEUTRAL

We cut earnings estimates for FY24/25 by 17%/3% adjusting our margin and credit cost expectations. We haven’t tweaked our growth assumptions but would like to see acceleration in disbursement growth in coming quarters. Margins are assumed to recover by a reasonable extent (adj. for product mix impact) in the next year when rates would likely soften. Credit cost needs to be too low in H2 FY24 for the annual guidance of 1.5-1.7% to be met. While roll backs and recoveries are usually stronger in H2 of a year, the reduction in GNPLs through collections will have to be significant and writeoffs needs to be lower for achievement of management’s credit cost guidance. It is plausible that better behaviour of the portfolio (better underwriting and customer selection since Mar’22) and resetting of ECL model to a lower LGD could drive moderate credit cost next year. However, in the near term we see valuation taking a knock as RoE improvement trajectory has been stalled. We downgrade the stock to NEUTRAL with a lowered 12m PT of Rs300.

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