Mahindra Finance (MMFS IN) Initiate OW: De-risked rural growth story 􀀗HSBC Research

Mahindra Finance (MMFS IN)
Initiate OW: De-risked rural growth story
􀀗 After three droughts and the global liquidity crisis, MMFS
has re-oriented and insulated itself from volatility
􀀗 We believe the share price has reflected the risks (regulatory,
drought, funding) but not potential growth
􀀗 Initiate with OW and a target price of INR780, implying
potential return of 26%; stock catalyst is lower rates

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A different rural story: The repositioning of Mahindra & Mahindra Financial Services
(MMFS) as a de-risked, rural growth story is not yet fully appreciated by the market, in
our view. We expect MMFS to outperform over the next year on less direct agricultural
exposure, diversification of funding base, relatively muted impact from regulatory
changes and peaking of interest rates. We have not factored in the benefits of other rural
reforms, including direct subsidy distribution using the ongoing Unique Identification
number (UID) initiative and land reforms, which could provide further upside.
Re-orientation equals high, stable growth: MMFS has restructured both sides of its
balance sheet to insulate against future crises. While retaining its rural focus, it has
diversified away from direct agricultural exposure to newer segments such as commercial
vehicles (CV) and utility vehicles (UV) and retained its focus on car loans, resulting in
customer diversification. This mitigates the risk of slower agricultural loan growth during
periods of drought. On the funding side, it has diversified from debentures to retail
deposits and bank funding, better hedging the company against another liquidity crisis.
Growth and profitability to normalise: FY11 and FY12 were good years when growth
rebounded and asset quality and profitability improved significantly from the earlier drought
periods. Although these trends should normalise given the higher base, we expect MMFS to
report 22%+ earnings growth, with ROA and ROE well above 3.5% and 24%, respectively,
over the next 3 years. The quality of earnings will likely improve given the change in asset and
liability mix. Our estimates are marginally above consensus by c5% for the next 3 years.
Regulatory risks: New NPL recognition norms, if finalised, could lead to a 50% jump in
NPLs (about 10% earnings impact). Recent securitisation guidelines could reduce its
ability to securitise, leading to c25bps reduction in margins on a worst case basis.
Initiate OW: MMFS trades at 12-month rolling forward PE of 8x and PB of 1.8x. It has
seen four distinct valuation phases in its six-year listing history. We believe the current
price is discounting increasing regulatory risks and a high rate environment. However, we
expect reasonably high growth and accordingly value the stock based on its current 12-
month rolling multiples of 8x PE and 1.8x PB on FY14 estimates. Blending these with our
EPM valuation, we arrive at a TP of INR780. The key stock catalyst is falling rates. Key
downside risks are: rigidity in rates, higher slippage, and regulatory uncertainties.