Initiating Coverage Mahindra & Mahindra Financecontent.indiainfoline.com/wc/research/researchreports/MMFSL_040613.… · business of financing purchase of new and pre‐owned utility

Sector: Financials

Sector view: Positive

Sensex: 19,610

52 Week h/l (Rs): 270/114

Market cap (Rscr) : 13,807

6m Avg vol (‘000Nos): 1,464

Bloomberg code: MMFS IB

BSE code: 532720

NSE code: M&MFIN

FV (Rs): 2

Price as on Jun 03, 2013

Company rating grid

Low High

1 2 3 4 5

Earnings Growth

RoA Progression

B/S Strength

Valuation appeal

Risk

Share price trend

80

120

160

200

240

Jun‐12 Oct‐12 Feb‐13 Jun‐13

MMFSL Sensex

Share holding pattern

‐

20

40

60

80

100

Sep‐12 Nov‐12 Dec‐12 Mar‐13

Promoters Institutions Others%

Rating: BUY Target (9‐12 months): Rs283

CMP: Rs243

Upside: 16.5%

Company ReportJune 04, 2013

Research Analyst: Bhavna Sinyal Rajiv Mehta

[email protected]

Mahindra & Mahindra Finance

Initiating Coverage

Prime pick Sturdy business model; brisk growth over FY10-13 Mahindra & Mahindra Financial Services Ltd (MMFSL), a subsidiary of M&M is one of the leading vehicle financing NBFCs in India with an AUM of Rs267bn. It has one of the largest rural and semi‐urban distribution franchises comprising 657 branches across 25 states and 4 UTs. Starting as a captive finance company for M&M products, the company has evolved into a diversified vehicle financier. MMFSL’s localized business model and nimble loan processing lends it with a strong pricing power. During FY10‐13, MMFSL witnessed robust AUM growth and sharp improvement in assets quality driven by rural upswing and structural factors such as network expansion, conservative LTV/loan tenor, robust credit appraisal/monitoring and strong collections engine.

Asset and earnings growth to slow but remain impressive In view of deep macro slow down and waning momentum in rural consumption, moderation in MMFSL’s disbursement growth is likely to accentuate in FY14 (~18% v/s ~22% in FY13) before recovering marginally in FY15. The deceleration in disbursements would translate into moderated though respectable asset growth of 23.5% pa over FY13‐15. MMFSL’s NIMs are favorably placed in a declining rate environment and therefore would remain firm despite increase in competition. Delinquencies could show an uptick and along with migration to 120‐day NPL recognition should drive a material increase in credit cost in FY14/15. Consequently, earnings growth is estimated to decelerate to 18‐20% over FY13‐15.

Valuation is not cheap but can remain so; initiate coverage with BUY MMFSL’s premium valuation amongst NBFCs (2.7x 1‐year roll fwd P/BV) is likely to sustain aided by better earnings growth and RoA delivery. Diversified business compared to other vehicle financiers and strong relationships with manufacturers lend higher predictability to MMFSL earnings growth. Key risks to our hypothesis would be a negative surprise in asset growth and asset quality. Initiate coverage on MMFSL with a BUY recommendation and 12‐month target price of Rs283 which includes forecasted value of Rs12.5 for insurance broking business and Rs4 for rural financing business.

Financial summary Y/e 31 Mar (Rs m) FY12 FY13 FY14E FY15E

Total operating income 16,743 22,759 28,929 35,787

Yoy growth (%) 27.1 35.9 27.1 23.7

Operating profit (pre‐provisions) 10,823 15,340 19,804 24,746

Net profit 6,201 8,827 10,234 12,326

yoy growth (%) 33.9 42.3 15.9 20.4

EPS (Rs) 12.1 15.7 18.2 21.9

Adj. BVPS (Rs) 57.5 74.5 87.4 101.0

P/E (x) 20.1 15.5 13.4 11.1

P/Adj.BV (x) 4.2 3.3 2.8 2.4

ROE (%) 21.3 16.4 14.1 11.7

ROA (%) 4.5 3.4 2.9 2.5

CAR (%) 18.0 19.7 18.3 17.4 Source: Company, India Infoline Research

Mahindra & Mahindra Financial Services Ltd

2

Mahindra & Mahindra Financial Services Ltd – a leading vehicle financing company in India Mahindra & Mahindra Financial Services Ltd (MMFSL), a subsidiary of Mahindra and Mahindra Limited (M&M), is one of the leading non‐banking finance companies in India. It has a strong distribution network of 657 offices, covering 25 states and 4 union territories, specially catering to rural and semi‐urban areas. MMFSL is in the business of financing purchase of new and pre‐owned utility vehicles, tractors, cars, commercial vehicles, construction equipments and SME Financing, and had an AUM of Rs267bn at the end of FY13. About 98% of the asset portfolio is vehicle financing, of which, ~91% is new vehicle financing and residual ~7% is used vehicle financing. Company has entered into over 2.5mn vehicle finance customer contracts since inception, of which, ~1.3mn are active currently. SME financing, started a couple of years back to finance M&M suppliers, is less than 2% of assets with the book standing near Rs4.5bn. MMFSL commenced operations in 1993 as a captive finance company for M&M products that had significant market in rural and semi‐urban areas. Post 2002, after gaining substantial share within M&M vehicle sales, company started financing non‐competitive products of other manufacturers to expand operations. This led to creation of new business segments such as car financing, commercial vehicle/construction equipment financing and pre‐owned vehicle financing. MMFSL’s strong foothold in semi‐urban and rural areas made it the preferred choice for auto manufacturers like Maruti that was planning to expand its sales in the hinterlands of the country. Currently, MMFSL is the second largest financier of Maruti vehicles, probably the largest in rural areas. Since a few years, company has also been financing competing products such as UVs and Tractors of other manufacturers. MMFSL through its direct marketing initiative is strengthening relationships with non‐M&M dealers. This evolution of the company has significantly strengthened MMFSL’s business by reducing concentration to products thereby making its growth de‐risked and resilient. Presently, the non‐M&M portfolio comprises ~50% of assets financed. MMFSL has built a strong brand reputation in rural and semi‐urban areas with its customer‐oriented business model, diverse product offerings and deep presence. Group Structure

51.20%

Mahindra InsuranceBrokers Limited

(MIBL)

Mahindra Rural HousingFinance Limited(“MRHFL”)

Mahindra Finance USA LLC(JV with Rabobank Group

subsidiary)

Mahindra Business &Consulting ServicesPrivate Limited

85.0% 87.5% 49.0% 100%

Mahindra & Mahindra

Ltd


Source: Company, India Infoline Research


3

Niche business model built on strong tenets; no significant threat of competition MMFSL positioning of being nimble than a bank and cheaper than a money lender has given expression to aspirations of millions of vehicle owners in the rural and semi‐urban areas. Around 80% of vehicle financed by the company are used for earnings purpose and balance 20% (mostly cars/UVs) for consumption. It is highly interactive lending done by empowered local field officers as customers usually do not have necessary documentation supporting their creditworthiness. Therefore, the local field officers need to have strong knowledge about that particular region, crops/yields, other economic activities, customers, etc and should be well‐versed with the local language. Loan sanctions are done at branch level with the joint decision of branch manager (who cross examines the field officer about his evaluation of the customer) and branch accountant (who handles KYC and loan documentation and may also call customers for identity verification). Business underwriting is done on strong principals of tight control on LTV and tenor. Average tenor of loans is around two years for used vehicles, three years for cars/UVs and four years for tractors and MHCVs. Further, the company does not restructure installments or the loan. Field and branch officers are interchanged every 12‐15 months to ensure internal discipline and to avoid any kind of fraudulent lending. Branches cannot sanction more than one loan per family and such requests require approval of higher authority. The field officers also collect the monthly instalments from the clients and they are provided with handheld devices which has all the information of their customers and which also prints receipts for the cash collected. Currently, 65% of the collection is in cash form; it used to be around 80‐85% before the introduction of Car/CV financing. Through the handheld devices, branch and the central office can keep track of all the loans on a real‐time basis. MMFSL has brought in various innovations into the business to improve operational efficiency, strengthen customer relationship, deepen its market insight, enhance profitability and effectively compete with other players in the market. It offers a fast turnaround of two days compared to 5‐6 days for other NBFCs and 10‐12 days for banks. Many private and public sector banks are rapidly growing their rural branch network to tap rural financing opportunities and achieve their financial inclusion and PSL targets. Nonetheless, quick disbursement, relatively lower documentation and flexible repayment options gives MMFSL an edge over banks. Competition from other NBFCs like Shriram Transport Finance, Sundaram Finance, Magma Fincorp etc is insignificant currently given their different product strategy and regional focus. Even if competition from them intensifies, the market opportunity is large enough for all players to grow.

80% of vehicle financed by MMFSL are used for commercial purpose

Being nimble than a bank and cheaper than a money lender, MMFSL enables customers to avail loans that do not have necessary documentation

Business underwriting is done on strong principals of tight control on LTV and tenor

65% of the collection is in cash form

Offers a fast turnaround of 2 days compared to 5‐6 days for other NBFCs and 10‐12 days for banks

Competition from other NBFCs is insignificant currently given their different product strategy and regional focus


4

Key subsidiaries in rural home financing and insurance broking In May 2004, MMFSL started providing direct insurance broking for the retail and corporate customers in rural and semi urban areas and offering a range of plans for the Life as well as Non‐life insurance segments, through its subsidiary Mahindra Insurance Brokers Ltd. (MIBL). In September 2011, MIBL was granted a composite broker license by the IRDA, thus foraying into the Reinsurance Broking business along with Direct Broking. During 2013, MIBL sold 15% stake to Inclusion Resources Private Limited. In August 2007, MMFSL commenced its housing finance business providing loans for home construction, purchase, extension and improvement in rural and semi‐urban areas through its subsidiary Mahindra Rural Housing Finance Ltd (MRHFL). National Housing Bank (NHB) owns a 12.5% equity interest in MRHFL. MRHFL operates in nine states including Gujarat, Maharashtra, Andhra Pradesh, Karnataka, Tamil Nadu and Kerala. The loan book has been growing at a fast clip and stood at Rs8.8bn at the end of FY13. Average ticket size of loans is around Rs1lac and average tenor is 5‐7 years.

During 2013, MIBL sold 15% stake to Inclusion Resources Private Limited

Outstanding housing loan book stood at Rs8.8bn as on Mar’13

Extensive branch network compared to peers Better asset mix than peers

539518

275

657

200

300

400

500

600

700

MMFSL STFC Chola Finance Magma Fin

(Nos.)

0%

20%

40%

60%

80%

100%

MMFSL STFC Chola

Finance

Magma Fin

CV & CE Pre‐owned Car/UV/2W Tractors SME Mortgage


MRHFL: Loan and PAT CAGR of ~89% and ~110% respectively over FY10‐13

MIBL: Turnover and PAT CAGR of ~40% and ~46% respectively over FY10‐13

0

2

4

6

8

10

FY10 FY11 FY12 FY13

(Rs bn)

0

50

100

150

200

250

Loan Book PAT (RHS)

(Rs mn)

0

200

400

600

800

1,000

FY10 FY11 FY12 FY13

(Rs mn)

100

160

220

280

340

400

Turnover PAT (RHS)

(Rs mn)



5

FY10 FY13 FY10‐13

Vehicle Segments EVAF (mn)

Share (%)

EVAF (mn)

Share (%)

CAGR (%)

Growth Drivers

Auto/UV ‐ M&M 31,204 35.0 73,900 31.0 33.3 Robust growth in underlying M&M UV sales driven by successful product launches

Tractors ‐ M&M 18,722 21.0 45,293 19.0 34.2 Strong growth result of healthy M&M volume sales, prices increases, deepening financing penetration and market share gains

Cars & Non‐M&M UVs/Tract

25,855 29.0 57,213 24.0 30.3 Robust rural volume growth for Maruti + price increases, impressive penetration in other manufacturers UV/Tractor financing

CV & CE 6,241 7.0 33,374 14.0 74.9 Strong LCV industry volume growth + prices increases + small base

Pre‐owned vehicles & others

7,132 8.0 28,606 12.0 58.9 Reduction in the average holding period of Cars, UVs + small base

Total 89,154 ‐ 238,386 ‐ 38.8 Source: Company, India Infoline Research # EVAF is Estimated Value of Assets Financed (Gross)

Impressive asset growth on increasing base over FY10-13 MMFSL has witnessed a robust AUM CAGR of 37% over FY10‐13. Aided by increase in financing penetration and market share gains led by strong network expansion, growth in MMFSL’s disbursements (38‐40% over FY10‐13) has been significantly higher than market volume growth of products financed. Marginal increase in LTV in a couple of segments also helped disbursement growth in the past two years. Company benefited from its diversified presence across vehicle segments which enabled it to overcome underlying volume weakness in any of its segments. Within the asset mix, the share of CV/CE loans (large portion is LCV loans) and used‐vehicles loans has increased over the past two years whereas the contribution of tractor loans and car loans has declined. M&M products share in AUM has declined from 56‐57% in FY10 to 53‐54% in FY13 due to faster growth in non‐M&M business.

AUM reported a robust CAGR of 37% over FY10‐13

M&M products share in AUM has declined from 56‐57% in FY10 to 53‐54% in FY13

AUM mix as on March 2013 AUM CAGR of ~37% over FY10‐13

32.0%

19.0%

27.0%

15.0%

7.0%

Auto/UV (M&M)

Tractors (M&M)

Cars & Non

M&M Vehicles

CV & CE

Pre‐owned

vehicles and

0

50

100

150

200

250

300

FY10 FY11 FY12 FY13

Auto/UV (M&M) Tractors (M&M) Cars & Non M&MCV & CE Pre‐owned

(Rs bn)

CAGR 36.8%



6

Share of CV&CE and pre‐owned vehicles has increased in the asset mix

38 33 31 30 32

2523 23 20 19

2430 31

31 27

7 8 9 12 15

6 6 6 7 7

0%

20%

40%

60%

80%

100%

FY09 FY10 FY11 FY12 FY13

Auto/UV (M&M) Tractors (M&M) Cars & Non M&M CV & CE Pre‐owned


Barring UVs and LCVs there has been a sharp volume growth slowdown in other segments

For M&M, UVs volume growth has been robust but tractor volumes have been weak

(40)

(20)

0

20

40

60

FY10 FY11 FY12 FY13

(%)

Cars Uvs Tractors LCVs M&HCVs

43.5

10.8

19.5

30.631.3

21.7

9.5

(4.6)(10)

0

10

20

30

40

50

FY10 FY11 FY12 FY13

(%) UVs Tractors


Significant branch expansion in past few years Growth in EVAF during FY13 was better than industry volume growth of underlying products

436 436459

547

607

657

200

300

400

500

600

700

FY08 FY09 FY10 FY11 FY12 FY13

(Nos.)

41.9

61.7

35.3

22.2

0

15

30

45

60

75

FY10 FY11 FY12 FY13

(%)



7

Moderation in disbursement growth in FY13 was accompanied by a lower repayment ratio

….enabling MMFSL to sustain strong AUM growth; but disbursement weakness to show‐up in FY14/15

10

20

30

40

50

60

FY10 FY11 FY12 FY13 FY14E FY15E

(%)

45

48

51

54

57

60

Disbursement growth Repayment/Opening AUM % (RHS)

(%)

24.9

37.7 38.234.5

24.522.5

0

8

16

24

32

40


(%)


Assets growth to slow down materially over FY13-15E MMFSL witnessed material moderation in disbursement growth during FY13 (~22% v/s ~35% in FY12) tracking the weakness in the underlying volume growth in key segments of M&M UVs, M&M Tractors and Cars/Non‐M&M UVs and Tractors. Asset growth did not manifest a sharp slowdown in FY13 though (35% v/s 38% in FY12); understandably due to robust disbursement growth in the previous two years and increase in the average tenure of loan (repayment/opening assets ratio seems to have fallen sharply in FY13). In our view, deep slow down in economic activity (80% of vehicle financed are used for earning) and moderation in rural consumption would further undermine MMFSL’s disbursements growth through FY14 (~18% v/s ~22% in FY13). In FY15, disbursements growth is expected to improve (~20% v/s ~18% in FY14) on the back of revival in industrial/infra activity, lower interest rates and higher earnings/income visibility for customers. On the back of slower disbursement growth and higher base, the asset growth is estimated to slow down materially to 24% over FY13‐15 as compared to 37% over FY10‐13. The share of M&M portfolio in the asset mix is expected to further decline by FY15 with stronger growth in other segments.

FY15 Vehicle Segments

FY12 EVAF

(%yoy)

FY13 EVAF

(%yoy) EVAF (mn)

Share (%)

FY13‐15CAGR (%) Growth Comments

Auto/UV ‐ M&M

39.8

22.2

104,642

30.9

19.0

M&M's UV volume growth to moderate due to macro slow down and strengthened competition

Tractors ‐ M&M

23.0

16.1

58,347

17.2

13.5

M&M's tractor volume growth recovery could be weak. Demand hit by higher prices/interest rate and diminishing alternate applications

Cars & Non‐M&M UVs/Tract

30.4

8.6

72,374

21.4

12.5

Rural volume growth of Maruti expected to be resilient. Strong desire of other car makers to grow in the hinterland. MMFSL to gain further inroads in non‐M&M tractor/UV financing

CV & CE

47.6

42.6

55,101

16.3

28.5 Sustained strong demand for LCVs to support robust disbursement growth. LCV financing is about 60‐65% of this segment.

Pre‐owned vehicles & others

50.3

46.7

47,967

14.2

29.5

Expanding used‐vehicle financing market to underpin strong disbursement growth

Total 35.3 22.2 338,430 ‐ 19.2 Overall disbursement growth to moderate marginally from FY13 level

Source: Company, India Infoline Research; # EVAF is Estimated Value of Assets Financed (Gross)

Disbursement growth moderated in FY13 (~22%) compared to ~35% in FY12 Disbursement growth is expected to be around 20%; slightly better than FY15 Share of M&M portfolio in AUM is expected to further decline by FY15 with stronger growth in other segments


8

Lower reliance on bank term loans and assignments as compared to peers

Shift in borrowing mix towards NCDs and FDs over FY11‐13

51 51 52

35

12

37

14

33

0

20

40

60

80

100


Bank Term Loans Assignment(%)

3445

57 55 51

22

21

17 1412

40 27 19 2225

1 6 7 8 11

0%

20%

40%

60%

80%

100%


Bank Term Loans Assignment CP/ICD NCDs FDs


Expect further increase in share of CV&CE and Pre‐owned vehicles in FY14/15 EVAF

35 30 31 31 31 31

2122 20 19 18 17

2928 27 24 23 22

7 11 1214 15 16

8 9 10 12 13 14

0%

20%

40%

60%

80%

100%


Auto/UV (M&M) Tractors (M&M) Cars & Non M&M CV & CE Pre‐owned

Source: Company, India Infoline Research Liability franchise has strengthened in recent years MMFSL liability profile comprises of bank term loans (51%), NCDs (25%), public fixed deposits (11%) and Assignments (12%). It is more diversified and therefore stronger than many other NBFCs who substantially rely on bank borrowings and assignments. MMFSL’s brand equity and robust credit rating enables it to raise stable long‐term funds via NCDs (rated AA+) and fixed deposits (rated FAAA by CRISIL) at economical rates. The duration profile of NCDs/FDs is matching with duration of assets thereby reducing ALM risks. Over FY11‐13, the share of such stable funding has significantly increased (from 26% to 36%) with reduction in dependence on bank borrowings (declined from 57% to 51%) and assignments (declined from 17% to 12%) thereby making the liability franchise stronger. About 80‐85% of bank loans are linked to base rate and therefore 40‐45% of borrowings are at floating rate.

More diversified and stronger borrowing profile than many other NBFCs

80‐85% of bank loans are linked to base rate; 40‐45% of borrowings are at floating rate


9

NIM to remain stable - benefits of easing funding cost likely to be passed on MMFSL has been earning impressive NIMs in the range 9‐9.5% (computed). Robust margin has been a function of strong pricing power (stemming from unmatchable reach and prompt loan processing) and frugal funding base (underpinned by a high credit rating). Though borrowing cost increased in the past two years, blended yield (computed) of MMFSL has also improved though not commensurately. The lending yield improvement is likely to have been driven by stronger disbursements of UV loans and used‐vehicle loans attracting higher rates and also marginal increase in the blended LTV. There is typical seasonality in quarterly NIMs of MMFSL on account of underlying seasonality in asset quality. Gross NPAs spike up in first half of a fiscal (prior to monsoons and during monsoons) and subside in the second half due to robust collections on the back of improved cash flow of customers. Therefore interest reversals suppress NIM in the first nine months while in the fourth quarter most of this gets recognized again due to customer repayments. Seasonality in NIM on account of underlying seasonality in asset quality

2

3

4

5

6

7

Q1 FY11

Q2 FY11

Q3 FY11

Q4 FY11

Q1 FY12

Q2 FY12

Q3 FY12

Q4 FY12

Q1 FY13

Q2 FY13

Q3 FY13

Q4 FY13

(%)

8.5

9.0

9.5

10.0

10.5

11.0

11.5

GNPA ratio NIM (RHS)(%)

Source: Company, India Infoline Research The outlook for NIM is sanguine despite considering that MMFSL’s pricing power could weaken by the penetrating competition. The asset‐liability duration is favorably placed for a declining interest rate environment. As we expect monetary transmission to pick up and further reduction of policy rate by the RBI through the fiscal, the cost of bank funding is estimated to decline materially. On the NCD portfolio also, average cost would decline as incremental borrowing rates are ~100bps lower. However, there are certain low‐cost borrowings that may get adversely re‐priced during the year. The forecasted asset mix movement (towards UVs, used vehicles and CV/CE segments) should also aid margin. We therefore believe that MMFSL would get enough headroom to respond to intensifying competition without compromising its margins.

NIM trended in the range of 9‐9.5% in last few years; highest among peers

Robust margin has been a function of strong pricing power and frugal funding base

Seasonality in NIM on account of underlying seasonality in asset quality

Asset‐liability duration is favorably placed for a declining interest rate environment

The forecasted asset mix movement should further aid margin.


10

NIM to remain stable as benefits of easing funding cost are passed on

10.3

9.3 9.4 9.3 9.4

6

7

8

9

10

11

FY11 FY12 FY13 FY14E FY15E

(%)

Source: Company, India Infoline Research Firm NIM and success in direct marketing to drive some improvement in cost/income ratio At the core, asset growth for MMFSL is a function of increase in field employees/branches, geographic penetration and improvement in employee/branch productivity. The employees and branch count has grown by 17% pa and 13% pa respectively over FY10‐13 and their business productivity has improved by 65% and 89% respectively over the period. The substantial improvement is operating efficiency has driven a decline in company’s cost/income ratio from 36% in FY11 to 33% in FY13. The current cost/avg.assets ratio at just above 3% is probably amongst the best in the industry.

Substantial improvement in productivity drove a steep decline in C/I ratio from 36% in FY11 to 33% in FY13

Earning significantly higher NIM (FY13) than peers Net spread to marginally improve over FY13‐15E

9.4

7.1 7.0

4.2

0

2

4

6

8

10


(%)

5.5

6.0

6.5

7.0

7.5

8.0


(%)



11

Being present in large number of districts in India, MMFSL is now planning to enter deep into the remote areas. Company intends to add smaller branches, an extension to its already existing branches, catering to distant customers in remote villages where it foresees good business opportunity. In moderating asset growth scenario, the scope for further improvement in employee/branch productivity would be limited, in our view. Over the past two years, MMFSL has started direct marketing initiative to generate business rather than completely relying on dealers. The efforts have started to reap benefits as ~15% of incremental business is now being generated by the company itself thus saving dealer commissions. This along with firm NIMs would ensure that income grows marginally ahead of the cost over FY13‐15. A decline in PCR, from 86% in FY11 to 66% in FY13, may raise concerns. Consequently, the Net NPA ratio has risen from 0.6% in FY11 to 1% in FY13. Given the kind by ~1% in next 3 years, if these guidelines are made mandatory

~15% of incremental business is now being generated by the company itself thus saving dealer commissions.

Branch productivity (EVAF/Branch) has improved substantially

… on the back of sharp improvement in employee productivity (EVAF/ Employee)

100

150

200

250

300

350

400

FY10 FY11 FY12 FY13

(Rs mn)

CAGR 23.7%

5

9

13

17

21

25

FY10 FY11 FY12 FY13

(Rs mn)CAGR 17.4%


Productivity improvement has driven a decline in Cost/Income ratio

Underlying improvement in Cost/Avg. AUM ratio

35.4

32.631.5

30.9

36.3

22

25

28

31

34

37

40


(%)

3.9

3.5

3.2

3.0 3.0

2.5

2.9

3.3

3.7

4.1

4.5


(%)



12

Sharp improvement in Gross NPA ratio driven by stringent underwriting and favourable environment

PCR decline attributable to lower than commensurate credit cost

8.7

6.4

4.0

3.0 3.0

0

2

4

6

8

10


(%)

40

50

60

70

80

90


(%)

0

100

200

300

400

500

PCR (LHS) Credit Cost (RHS)

(%)


Stringent underwriting back strong asset quality; credit cost to increase materially though Notwithstanding the marginal increase in blended LTV of the assets, asset quality has demonstrated consistent improvement with Gross NPA ratio declining from 8.7% in FY09 to 3% in FY13. Unlike most other NBFCs, MMFSL has been recognizing NPLs on 150 days past due (dpd) basis against the current regulatory requirement of 180dpd. Also, it does not restructure installments or loan. The reduction in GNPL level is attributable to robust credit appraisal by local field officers, conservative LTV and loan tenor approach, strong collections engine and a general upswing in rural incomes strengthening repayment capacity of customers. LTVs are determined by the type of loan, loan tenor, customer’s current financial health and evaluated repayment capability. With around 80% of vehicles financed used for earning by customers, the tenor of the loans is generally capped at 2 years for used vehicles, 4 years for tractors and 3 years for all other segments. On the back of low delinquencies, credit cost in the past three years has ranged 100‐130bps, significantly lower than 250‐300bps built by MMFSL during lending. However, the decline in PCR from 86% in FY11 to 66% in FY13 is slightly concerning. Consequently, the Net NPLs have risen from 0.6% to 1%.

Operating in rural areas, the customers are exposed to the vagaries of monsoons and fluctuations in economic activities. Therefore, in case of circumstantial NPLs, MMFSL generally does not repossess the asset for liquidation, but would provide time to the customer to upgrade. However, the company charges a penal interest for delay in payment in order to safeguard the contracted IRR. Typically seen with MMFSL is that GNPAs usually spike in the first half of a fiscal and subsides by the end of the fourth quarter due to underlying seasonality in customer repayments. The slowdown in rural economic activity (due to lackluster industrial activity, infra development, construction, mining, etc) and substantial increase in fuel costs could likely hurt repayment capacity of some customers and therefore stress MMFSL’s asset quality in FY14. Further the regulatory shift to 120dpd NPL recognition in FY15 would push the GNPL ratio further higher.

Gross NPA ratio witnessed steep decline from 8.7% in FY09 to 3% in FY13 Credit cost in the past three years has ranged 100‐130bps

PCR dropped from 86% in FY11 to 66% in FY13; resultantly Net NPLs rose from 0.6% to 1%

GNPAs spikes in the H1 of a fiscal and subsides by Q4 due to underlying seasonality in customer repayments


13

Delivered best‐in‐class RoA and RoE in FY13 Higher credit cost to weigh on return ratios in coming years

0.0

5.0

10.0

15.0

20.0

25.0


(%)

0.0

1.0

2.0

3.0

4.0

5.0

RoE (LHS) RoA (RHS)

(%)

2.5

2.8

3.1

3.4

3.7

4.0


(%)

15.0

17.0

19.0

21.0

23.0

25.0

Ret on Avg.AUM Ret on Avg. Equity (RHS)

(%)


Consequently, we build in an increase in credit cost to 150bps in FY14 and 175bps in FY15. Such level of provisioning should enable the company to sustain or marginally improve PCR from current levels. Higher stress and shift to 120dpd NPL recognition to push GNPL ratio and credit cost higher

0.0

2.0

4.0

6.0

8.0


(%)

0

100

200

300

400

GNPA ratio Credit Cost (RHS)

(%)


Robust capitalization post the recent QIP issue; RoA/RoE to moderate but remain impressive MMFSL’s Tier‐I ratio received a strong boost from Rs8.7bn QIP issue in November 2012. As at the end of FY13, the tier‐1 capital stood at robust 17% being significantly higher than the minimum regulatory requirement. In our view, current capitalization would be more than adequate to fund the estimated asset growth over the next two years. Over FY11‐13, MMFSL has delivered best‐in‐class return ratios aided strong NIMs, operating efficiency improvement and benign credit cost. Average RoA (based on average AUM) and RoE in the aforesaid period stood at robust 3.7% and 22.9% respectively. We forecast some moderation in the profitability levels over FY14‐15 with average RoA and RoE declining to 3.4% and 21.2% respectively. Albeit, this would still be one of the best in the industry as return ratios of most NBFCs is expected to moderate due to macro stress and regulatory headwind.

Tier‐I ratio boosted by QIP issue from Rs8.7bn in November 2012

Average RoA (based on average AUM) and RoE stood at robust 3.7% and 22.9% respectively over FY11‐13


14

Trading at 2.9x 1‐yr rolling fwd P/BV … significantly higher than 5‐year mean of 1.9x

0

50

100

150

200

250

300

Mar‐08

Sep‐08

Mar‐09

Sep‐09

Mar‐10

Sep‐10

Mar‐11

Sep‐11

Mar‐12

Sep‐12

Mar‐13

(Rs)

1.1x

3.1x

2.6x

2.1x

1.6x

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Mar‐08

Sep‐08

Mar‐09

Sep‐09

Mar‐10

Sep‐10

Mar‐11

Sep‐11

Mar‐12

Sep‐12

Mar‐13

(x)

1yr Fwd P/Adj.BV Mean Fwd P/Adj.BV

Source: Company, India Infoline Research, Bloomberg

Valuation is not cheap but can remain so; initiate coverage with BUY For NBFCs, valuation typically tracks earnings growth and RoA. Driven by robust earnings growth over FY11‐13 and superior RoAs, MMFSL valuation has seen substantial re‐rating. The stock currently trades at 2.7x 1‐year rolling fwd P/BV as compared to 1.6x 12 months ago. On relative basis, valuation is much higher than other NBFCs though justified by its diversified robust business model and higher RoAs. With company’s rural home financing and insurance broking subsidiaries have achieved scale, MMFSL stock price also reflects their value.

We estimate earnings growth to decelerate sharply over FY13‐15 due to slow down in headline revenue growth and higher credit cost. However, at 18‐20% it would still be respectable in an adverse macro environment and also better than most peers. We therefore think MMFSL’s premium valuation can sustain unless there is a negative surprise on asset growth and asset quality. We initiate coverage on MMFSL with a BUY recommendation with 12‐month target price of Rs283. The target price includes the forecasted value of Rs12.5 for insurance broking business and Rs4 for rural financing business.

Rich valuation justified by higher RoA delivery

1.0

1.3

1.6

1.9

2.2

2.5

1.0 1.5 2.0 2.5 3.0 3.5 4.0

Avg.ROA % (FY14‐15E)

FY15E P/BV (x)

SUF

STFC

MGMA

CIFC

MMFSL

Source: Company, India Infoline Research, Bloomberg

Higher valuation compared to peers is justified by its diversified robust business model and higher RoA

Earnings growth to decelerate sharply over FY13‐15

Premium valuation can sustain unless there is a negative surprise on asset growth and asset quality


15

Financials Income statement Y/e 31 Mar (Rs mn) FY12 FY13 FY14E FY15E

Operating Income 27,677 38,567 48,482 58,291

Interest expense (11,203) (16,188) (20,028) (23,097)

Net interest income 16,474 22,379 28,454 35,193

Non‐interest income 269 380 475 594

Total op income 16,743 22,759 28,929 35,787

Total op expenses (5,920) (7,419) (9,125) (11,042)

Op profit (pre‐prov) 10,823 15,340 19,804 24,746

Provisions (1,570) (2,834) (4,529) (6,349)

Exceptional Items ‐ 286 ‐ ‐

Profit before tax 9,253 12,792 15,274 18,397

Taxes (3,051) (3,965) (5,040) (6,071)

Net profit 6,201 8,827 10,234 12,326

Balance sheet Y/e 31 Mar (Rs mn) FY12 FY13 FY14E FY15E

Equity Capital 1,027 1,126 1,126 1,126

Reserves 28,483 43,420 51,694 61,734

Networth 29,510 44,546 52,820 62,860

LT borrowings 92,907 130,153 164,243 201,233

Other LT liabilities 487 2,430 2,673 2,860

LT provisions 4,022 3,104 4,812 7,175

Total Non‐cur liab 97,417 135,687 171,727 211,268

ST Borrowings 14,491 13,012 16,420 20,118

Trade payables 3,765 4,789 5,747 6,896

Other current liab 36,299 50,372 63,566 77,881

ST provisions 4,133 6,518 9,340 13,325

Total Current liab 58,688 74,691 95,072 118,221

Equity + Liab 185,616 254,924 319,620 392,349

Assets

Fixed Assets 989 1,068 1,175 1,292

Non‐current inv. 2,131 3,451 3,900 4,602

DTA (Net) 2,012 2,382 2,501 2,626

LT loans 92,577 129,198 165,612 208,141

Other non‐cur assets 152 1,706 1,979 2,276

Total Non‐cur assets 97,862 137,805 175,166 218,937

Current inv. 2,894 2,159 2,440 2,879

Trade receivables 77 98 123 153

Cash 2,300 3,454 4,740 4,854

ST loans 82,408 111,186 136,895 165,230

Other current assets 75 222 258 296

Total Current assets 87,754 117,119 144,454 173,412 Total Assets 185,616 254,924 319,620 392,349

Key ratios Y/e 31 Mar FY12 FY13 FY14E FY15E

Growth matrix (%)

Net interest income 26.3 35.8 27.1 23.7

Total op income 27.1 35.9 27.1 23.7

Op profit (pre‐provision) 29.0 41.7 29.1 25.0

Net profit 33.9 42.3 15.9 20.4

Advances 41.1 37.4 25.8 23.4

Borrowings 49.8 33.3 26.2 22.5

Total assets 35.7 37.3 25.4 22.8

Profitability Ratios (%)

NIM 9.3 9.4 9.3 9.4

Non‐int inc/Total inc 1.6 1.7 1.6 1.7

Return on Avg Equity 22.8 23.8 21.0 21.3

Return on Avg Assets 3.8 4.0 3.6 3.5

Per share ratios (Rs)

EPS 12.1 15.7 18.2 21.9

Adj.BVPS 57.5 74.5 87.4 101.0

DPS 2.0 2.6 3.0 3.5

Valuation ratios (x)

P/E 20.1 15.5 13.4 11.1

P/Adj.BVPS 4.2 3.3 2.8 2.4

Other key ratios (%)

Loans/Borrowings 162.9 167.9 167.4 168.7

Cost/Income 35.4 32.6 31.5 30.9

CAR 18.0 19.7 18.3 17.4

Tier‐I capital 15.1 17.0 16.1 15.6

Gross NPLs/Loans 3.0 3.0 3.3 3.8

Credit Cost 1.0 1.3 1.5 1.8

Net NPLs/Net loans 0.7 1.0 1.2 1.6

Tax rate 33.0 31.0 33.0 33.0

Dividend yield 0.8 1.1 1.3 1.5

Recommendation parameters for fundamental reports:

Buy – Absolute return of over +10%

Market Performer – Absolute return between ‐10% to +10%

Sell – Absolute return below ‐10%

Published in 2013. © India Infoline Ltd 2013 This report is for the personal information of the authorised recipient and is not for public distribution and should not be reproduced or redistributed without prior permission. The information provided in the document is from publicly available data and other sources, which we believe, are reliable. Efforts are made to try and ensure accuracy of data however, India Infoline and/or any of its affiliates and/or employees shall not be liable for loss or damage that may arise from use of this document. India Infoline and/or any of its affiliates and/or employees may or may not hold positions in any of the securities mentioned in the document. The report also includes analysis and views expressed by our research team. The report is purely for information purposes and does not construe to be investment recommendation/advice or an offer or solicitation of an offer to buy/sell any securities. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. Investors should not solely rely on the information contained in this document and must make investment decisions based on their own investment objectives, risk profile and financial position. The recipients of this material should take their own professional advice before acting on this information. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. This report is published by IIFL ‘India Private Clients’ research desk. IIFL has other business units with independent research teams separated by 'Chinese walls' catering to different sets of customers having varying objectives, risk profiles, investment horizon, etc and therefore, may at times have, different and contrary views on stocks, sectors and markets. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to local law, regulation or which would subject IIFL and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. IIFL, IIFL Centre, Kamala City, Senapati Bapat Marg, Lower Parel (W), Mumbai 400 013. For Research related queries, write to: Amar Ambani, Head of Research at [email protected] or [email protected] For Sales and Account related information, write to customer care: [email protected] or call on 91‐22 4007 1000

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