Is M&M Financial Services off the hook?

Mahindra & Mahindra Financial Services (M&M Finance) is the country’s second largest automobile financier and the lender is well positioned to capture the rebound in demand for vehicles – whether commercial, passenger, including utility vehicles or tractors. In addition, the largest vehicle financier – Shriram Transport – is in the midst of a corporate overhaul which may require it to slow down the growth pedal. This could be an opportunity for M&M Finance to up its game.

Trading at 1.5 times price to book value, the stock is 21% below its five-year historical valuation. With lender asset quality on the mend, long-term investors may consider hoarding stocks. One could use any likely correction in his stock price to buy the stock.

Company presentation

M&M Finance began as a 100% captive financier for major automaker Mahindra & Mahindra, also its parent company. Since its IPO in 2006, it has driven down the share of assets financed by M&M (tractors and passenger cars) and currently at 45%, M&M Finance holds the leadership in the commercial vehicle lending space. Over the years, the company has become a healthy financial with exposure to passenger cars, tractors, utility vehicles and used vehicles. Lately, it has also made a foray into consumer lending, and over the next three to five years, the share of non-auto loans is expected to hit 20% of its overall loan portfolio. Although this is part of its diversification strategy, it will essentially remain a vehicle financier.

Covid-related pressures

In the financial year 2012-2020, M&M Finance grew its loan portfolio from ₹17,500 crore to ₹65,000 crore or at a CAGR of 15.7%, beating industry performance. In FY21, for the first time in about a decade, it had to reduce its loan portfolio (down 7.7% year-over-year) due to the pandemic. At ₹73,900 crore loan book as of Sep 30, 2022 (Q2 FY23), up 16% YoY (as per latest exchange filing), M&M Finance appears to have passed through the slow growth phase.

Asset quality

M&M Finance is among the few NBFCs that have yet to recover to pre-pandemic levels in the exchanges. Two factors led to its downgrade – shrinking loan book and asset quality. Now, with loan growth worries subsiding, combined with a broader market recovery from the lows, the stock has gained more than 60% from its 52-week low. The next phase of revaluation would depend on an improvement in asset quality.

According to the latest data, gross Tier 3 assets or gross non-performing assets were 7% in the second quarter of FY23, down 100 basis points (bps) sequentially and nearly 500 bps year-on-year. year-on-year. Therefore, the numbers are directionally positive.

M&M Finance’s NPA numbers have consistently outperformed its peers, primarily because its exposure to rural and semi-urban markets is at least 15-25% higher. Thus, the performance of M&M Finance is linked to the vagaries of the monsoon and the monsoon is an important purchasing orientation factor for borrowers in non-urban markets.

M&M Finance’s average gross NPA was around 6.3% between fiscal years 2012 and 2020. Although recent data shows improvement on this front, a return to pre-pandemic range could still take 12-18 months . That said, with much of the accelerated provisioning in the first quarter explaining the year-over-year decline in net income, there should be no unexpected jolts on that front.

Risks to consider

On a monthly basis, the lender repossesses 4,000 to 5,000 units of defaulted assets (classified as gross NPA). He expects the number of foreclosures to temporarily decrease after RBI banned the use of third-party agencies for loan recovery. In September, RBI banned M&M Finance from hiring third-party entities to repossess loan assets for collection. This was after an unfortunate incident during the recovery process by a third-party company agent. Sentiment on the stock turned sour after that and it corrected nearly 20% in two trading days after that ban. The stock has seen some recovery since then, however, and the company also clarified that this shouldn’t have a significant financial impact.

With a provision coverage ratio of 58% on gross NPAs and 100% on assets in default for more than 18 months, the likelihood of further impact on M&M Finance’s asset quality should not be severe. Provisional data for the second quarter point to an improvement on this front. However, the medium to long-term impact of this ban needs to be monitored, particularly in terms of operating costs, given that it is common industry practice to outsource the recovery process.

Much of M&M Finance’s revaluation is based on improving demand. However, as pent-up demand and the low base effect fade, one should watch whether demand would hold up given inflationary pressures. Yields are already under pressure for M&M Finance (15.8%, down 30 basis points sequentially), as is the sector, although its net interest margin (or profitability) at 8 .5% remains one of the best in the sector. If demand becomes lukewarm, the lender may face pricing issues. While the cost of funds remained optimistic in the first quarter at 6.5%, this could change by the December quarter.

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