Mahindra & Mahindra Financial Services: A Creditworthy Performance

Inclusive growth has been one agenda which has been at the top of the priority list of the government and the RBI. Consistent efforts have been made by the regulator for the same, with the provision for new banking licenses being the most recent. While banking licenses have been issued in the past too, the story was different this time around, with even Non-Banking Finance Companies (NBFCs) and corporate houses being allowed to participate. As expected, there has been a rush to the counter to apply for the banking license. However, Mahindra & Mahindra Financial Services (MMFSL) one of the largest NBFCs in India, has opted out of the race.

This company has surprised the street on many occasions in the past with a solid financial performance even in difficult economic scenarios. If we look at the factors behind its robust performance, two factors emerge categorically. A strong presence in the rural and semi-urban areas and a diversified loan portfolio are the prime factors that have helped MMFSL deliver strong growth in spite of the economic slowdown in the past.

The macro economic scenario has fallen on dismal days yet again, and it needs to be seen how MMFSL manages to sustain its growth now. The short-term cost of funds is rising significantly, which is impacting the margins. Automobile sales have been hit by the higher interest rates and the global markets are also yet to come out of the woods. Will MMFSL be able to weather these times?

A Model Business

MMFSL is a subsidiary of Mahindra & Mahindra (M&M) and is into the business of financing new and second-hand utility vehicles, tractors, cars, commercial vehicles and construction equipment. However, it is far from being totally dependent on its parent company. This is clear from the fact that nearly half of its lending finances other manufacturers’ vehicles.

Apart from these segments, the company has exposure to SME funding. Through its subsidiaries, it also caters as an insurance broker, MF distributor and real estate financer in rural areas. In terms of reach, it has 675 offices across 25 states and 4 union territories as on date.

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A Diversified Portfolio

Looking back at the history of MMFSL, the company began its operations in 1993, financing M&M vehicles. Over the years, it has been able to de-risk its loan portfolio and cater to other manufacturers as well. This opened up opportunities in newer segments such as cars, commercial vehicles and construction equipment financing, and in turn, helped the company reduce its dependence on any single segment or manufacturer.

Here’s an example of MMFSL’s strategy of de-risking by diversification. In 2012-13, the company increased its share of lending significantly to M&M’s Utility Vehicle (UV) segment and reduced its exposure to the ailing Commercial Vehicles (CV) segment. In the said fiscal, the share of the UV segment in the total assets financed increased to 31 per cent from 26 per cent in the previous year. As a result, the lending to this segment grew by a robust 46 per cent, backed by the underlying growth in M&M’s UV sales.

Another noticeable factor is that despite the slowdown in the passenger vehicle segment (which recorded lower sales), the business of MMFSL in the segment still grew by 12 per cent, aided by deeper penetration by financing cars of new manufacturers and an increase in market share.

Segment-wise Breakup of AUM (%)

Q2FY14: Tractors Lead The Way

Another recent example of the benefits from diversification is the poor performance of the auto segment compensated by improved performance of the tractor division. The monsoon has been encouraging this year, and with its rural reach, the company has been able put in a better performance in the tractor division. In fact, expectations of a good season were building up since the first quarter itself. In the June 2013 quarter, the share of tractors in the total assets financed increased to 21 per cent over that of 19 per cent in the June 2012 quarter. The management has also stated that in Q2FY14, the demand for tractors has compensated for the reduced sales in passenger cars and CVs.
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A Sustainable Run Rate?

The company has been able to sustain the growth in its loan book. This is evident from the 39 per cent annual growth seen on this front over FY11-FY13. Of course, in light of the troubled economic situation in the current fiscal, loan growth is expected to moderate from these levels. However, the company’s diversified business model should help it deliver close to 22-24 per cent growth over the next two years.

While the loan growth looks manageable, sustaining the spread is another major factor affecting the performance of financing companies. We are of the opinion that despite many odds like the recent sharp rise in the short-term lending rates and the impact seen on the long-term rates too, MMFSL is likely to sustain its margins. To understand why, let’s first take a look at the funding mix of the company.

Like its advances, MMFSL has a well-diversified funding mix as well. The company’s borrowing is spread across bank term loans (42 per cent), non-convertible debentures (28 per cent), fixed deposits (12 per cent), commercial paper (8 per cent) and securitisation (10 per cent).

The best part is it has also been able to maintain a prudential asset-liability match throughout the year. This means that the duration of its borrowings matches with that of its loans, thus mitigating the asset-liability risks. Following this, the company has logged impressive NIMs in the range of 9-9.5 per cent, a cut above its peers, which are in the range of seven per cent. For the June 2013 quarter, the gross spreads of the company were at 9.7 per cent. Of course, this was much lower than that of 10.30 per cent in June 2012 and 10.60 per cent in March 2013, but it is equally true that the economic scenario was quite different at those points.

The only concern here would be the recent tightening of liquidity by the RBI, which has resulted in a 250-300 basis points increase in cost of short-term funds. With 10 per cent of its portfolio being short-term, this is likely to impact the company’s margins. However the management has stated that they would be able to pass on the cost to consumers, and hence the margins would be unaffected.

Apart from this, MMFSL is looking at opportunities in the second-hand vehicle financing space, which is a high-margin business. The business currently contributes around eight per cent of the total assets financed by the company and has good growth prospects going ahead. So overall, we do not expect its margins to be affected.

Why It Opted Out Of The Banking Race

Given the strength in its business, MMFSL’s decision to step aside from the banking license race naturally came as a surprise for many on the street. On its part, the company, which has been both a catalyst to and a beneficiary of the Indian rural growth story, had a fairly convincing rationale for having done so.

The simple reason behind its decision was the regulations, which it felt would have necessitated letting go of growth opportunities. The set of guidelines behind the new banking license are actually disadvantageous for large NBFCs. The bone of the contention is the guideline that states that right from inception an NBFC that converts to a bank will attract CRR and SLR. For an NBFC like MMFSL, which has an asset base of around Rs 30000 crore, it would attract a CRR and SLR of around Rs 8000-9000 crore. So, rather than getting stuck in a scarce capital scenario, the company simply opted out of the race.
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Will Its Asset Quality Remain Intact?

One major worry for NBFCs has been the increasing NPAs. MMFSL, though, has maintained a consistent asset quality since its inception in spite of the growing macro concerns. The company has, in fact, been able to bring down its delinquencies over the past few years. In 2009-10, its Gross Non-Performing Assets (GNPAs) stood at 6.4 per cent of loans, which has come down significantly to three per cent in FY13. This has been achieved through a conservative Loan-to-Value (LTV) ratio (currently at 70 per cent), strong collections and a sound credit appraisal system.

However, the stringent asset classification norms may have an impact in the current fiscal. Currently, loans whose installments are overdue for 180 days or more are classified as NPAs. The Usha Thorat Committee Report on Issues and Concerns in the NBFC Sector has proposed to bring this down to 90 days for NBFCs in a phased manner, at par with banks. If brought to pass, this may result in higher provisioning costs. As of date, the company’s Gross NPAs stand at 4.2 per cent of its total assets against 3.9 per cent in June 2012 and three per cent in March 2013.

Strong Capital Adequacy

The company has been able to sustain good capital adequacy ratio. For June 2013, this was at 19.6 per cent, well above the statutory requirement of 15 per cent. The Tier I capital adequacy ratio stood at 16.4 per cent. It has sufficient capital cushion to drive growth over the next two years. The company has also been able to maintain healthy returns, with the return on assets (ROA) at around three per cent in June 2013 quarter and the return on net worth (RONW) at 16.8 per cent.

Unlocking Value In Subsidiaries 

MMFSL is also in the business of insurance broking and rural home finance through its subsidiaries. In FY13, the company sold 15 per cent of its stake in the insurance broking business to Singapore-based Inclusion Resources for a consideration of Rs 80 crore. The insurance business made a profit of Rs 34.40 crore in 2012-13. The financial performance of the company has been intact, with a profit of Rs 8 crore posted in June 2013 quarter as against Rs 7 crore in June 2012.

Mahindra Rural Housing Finance (MRHFL) provides home loans in rural and semi-urban areas, and its loan book stood at Rs 964.50 crore in the June 2013 quarter as against Rs 879 crore in March 2013. This company has also been able to put in a healthy financial performance, with its FY13 PAT at Rs 20 crore.

While both these businesses are profitable, they currently contribute only around five per cent of the company’s consolidated profit. Though both the verticals have good growth prospects, it would be too early to put any valuation to them.

Buoyant Financials, Premium Valuations

On the financial front, the consolidated performance of the company has been strong and its revenues have grown consistently. At the current price of Rs 260, the stock trades at 3x its current book value. While on a relative basis the stock seems expensive, the premium valuation is justified by a diversified loan portfolio and higher NIMs. With an expected earnings growth of 18-20 per cent for the next two years, the stock looks attractive even at these levels. However, taking into account the lingering macro issues, we advise investing in this counter with a two-to-three year time horizon.