Mahindra And Mahindra Financial Services : Takeaways from Management Conf Call :::Citi

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Mahindra And Mahindra Financial Services
(MMFS.BO)
Alert: Takeaways from Management Conf Call


 Management remains confident on rural growth — We had a conference call with
Mahindra Finance management - key takeaways: a) Management remains quite
confident on the performance of the rural segment, especially on the back of betterthan-
average monsoons; b) Seeing well-diversified growth in key products, de-risking
loan book further; c) Some NIM pressures likely, as management is reluctant to pass
higher lending rates to borrowers, but possible manufacturer subventions should be a
support; and d) Asset quality not a concern as economic activity remains healthy.
 Loan growth: Some dip likely, but should remain healthy — Management expects
loan growth to be slightly slower than in the recent past, though it should remain quite
healthy, driven by: a) Focus on rural segment - continued revenue buoyancy, high
labour and asset absorption rates; b) Increasing distribution network and higher finance
penetration; and c) Shift in underlying asset sales mix to more rural vs urban.
 Net interest margins: Product mix, delayed rate hikes could impact near term —
While NIMs could dip near term, overall profitability should remain constant: a) NIM dip
in 1Q12 was largely due to a shift in product mix to lower yield assets (e.g. CVs) - lower
NIMs but also lower opex, credit costs should protect ROAs; b) Incremental cost of
funds rising - now at 10 -10.25% - finds bonds as more attractive source of funding
currently; and c) Management reluctant to pass on higher cost of funds to borrowers,
could cause some NIM pain near term, but expects manufacturers to provide support in
the form of interest subventions to buyers (to maintain growth, margins).
 Asset quality: No signs of stress — Management remains confident of asset quality
performance - a) Historical high NPL levels not a reflection of current more diversified
portfolio mix, lower LTVs and rural health; b) Seasonally, 1H sees slower activity, but
repayments well within expected levels; c) No signs of broad portfolio stress yet; d)
Believes cars could be first to feel impact incomes do not rise, some delays in
payments starting; and e) NPL coverage levels can rise further from ~80% in 1Q12.
 Securitization impact not likely to be high — While securitization guidelines are still
pending, management believes adverse impact is limited, due to: a) Forms only 20-
25% of borrowings, impact on funding costs ~15-20bps, limited NIM impact and can be
priced into lending rates; and b) Liquidity is not a concern as bank funding available.
 Stable fundamentals, but challenging macro to weigh on valuations — While
Mahindra Finance’s operating fundamentals remain stable, we believe the expected
slowdown in loan growth, net interest margins and possible asset quality pressures will
likely weigh on its valuations and limit near-term upside.


Mahindra And Mahindra Financial Services
Valuation
We value Mahindra Finance at Rs650 per share based on our EVA model, which
captures the long-term value of the business and is a standard valuation measure for
the CIRA India banking coverage. Our EVA model assumes: a) a risk-free rate of 8%
(in-line with the current secondary market yields); b) longer-term loan loss provisions of
175bps given the company's higher asset risk profile; and c) loan spreads of 700bps
due to its higher-yielding asset profile. Our target price is also benchmarked off a 2.0x
1yr Fwd (Sep’12) P/BV, which is towards the lower end of our target multiples for
private sector banks (1.5x-3.5x) and at the higher end of its own historical multiples
(average 1yr Fwd P/BV over the previous cycle was 1.7x). Mahindra Finance trades
above its historical mean; we believe its valuations leave little upside given the current
high interest rates, rising cost of funds and slower-than-expected loan growth levels.
Risks
We rate Mahindra Finance shares Medium Risk, in line with our quantitative risk-rating
system, which tracks 260-day historical share price volatility. We believe Mahindra
Finance's large capital base, strong growth and high return profile moderates its risk
profile. Key upside risks that can cause the stock to trade above our target price
include: a) Higher than expected market share and loan growth; b) Continued
improvements in asset quality; c) Easy liquidity and low interest environment and d)
Regulatory changes.