M&M Finance

Investors with a high-risk appetite can consider fresh exposures in the stock of Mahindra and Mahindra Financial Services (M&M Finance). A 61 per cent subsidiary of auto company, Mahindra & Mahindra, M&M Finance is an asset financing non-banking finance company (NBFC). From being a captive financier of M&M’s vehicles, it has come a long way by diversifying into other segments such as commercial and pre-owned vehicles.

At the current market price of Rs 253.5, the stock trades at a modest 9.4 times its estimated FY-10 earnings and 1.82 times its adjusted book value as of September 30, 2009. In addition to modest valuations and earnings growth potential, high levels of capital adequacy, diversified presence in the auto segment, significant branch network with presence predominantly in the rural and semi-urban areas place the company in good stead. Strong sales in the auto segment and M&M’s extensive rural reach have contributed to the loan book growth for M&M Finance. Easing liquidity (enabling lower borrowing costs) and improvement in average collections led to strong earnings growth.

The company may continue this momentum as the automobile sector continues to grow at a strong pace, after being one of the earliest sectors to chart a recovery. The company’s gross non-performing assets stood at 9 per cent as of September. While stretched repayment cycles may lead to a higher NPA number, this may not always entail a higher default rate. High levels of NPA provision coverage and high levels of capital adequacy (17 per cent) also shield the company, to some extent, from any systemic adversities.
Business and Financials

The company’s advances book is well-diversified, comprising lending to buyers of utility vehicles (35 per cent of the portfolio), tractors (23 per cent), passenger cars (28 per cent), commercial vehicles (9 per cent) and pre-owned vehicles (5 per cent). Disbursements are increasing from the other segments while the tractor segment has seen a steady decline. However, the acquisition of Punjab Tractors by M&M may help M&M Finance increase disbursements to the tractor segment.

While captive lending may allow for an assured customer base, the company may face competition from other asset-financing peers as it tries to diversify especially into cars and commercial vehicles. Tractors, utility vehicles and refinance division are somewhat shielded from this threat with fewer organised players in this segment. To diversify its revenue mix and leverage on its branch network, the company has started an insurance broking and rural housing finance subsidiary. These subsidiaries have begun contributing in a small way to the company’s bottomline. With significant presence in the rural areas, M&M Finance may be able to pose stiff competition to housing financing companies and banks.

While the company’s borrowing profile of the company is quite diversified, it has increased its dependence on bank loans in the last few quarters due to unavailability of other avenues of financing. Bank loans, as a proportion of total borrowings, rose from 21 per cent to 39 per cent in the last 18 months. Securitisation is another funding avenue, as they fall under priority sector lending for banks. The RBI’s new directive that allows banks to assign risk weights for NBFCs according to their credit rating (instead of a standard weight) may reduce the borrowing costs for players such as M&M Finance with reasonable ratings (AA stable).

With this rating, banks can assign a 30 per cent risk weight to loans to M&M Finance compared to the existing 100 per cent risk weight, saving them capital.
Financials

M&M Finance’s net profit grew at an annual rate of 29 per cent during the period 2005-09 aided by a strong loan book growth of 24 per cent. For the six months ended September 30, 2009, the company has seen 9 per cent increase in disbursements. Improved spreads on the back of high yields and fall in borrowing and credit costs led to net profit growth of 79 per cent for the half year ended September 2009. Improving disbursements on the back of strong auto sales led to higher profit growth.

M&M Finance’s gross spreads are lingering at 11.1 per cent, but adjusted to the write-offs and provisions, net spreads look depressed at 3.8 per cent. Nonetheless, net spreads are likely to improve as provisions fall. Better collection efficiency may also lift profitability. While risk-aversion prevented the company from increasing the exposure to non-M&M financing in the past few months, the worst appears to be over on that score and the company may see higher disbursements from now on. Financing of pre-owned vehicles still forms a small portion but has huge potential, given the high yields.
Outlook

A significant part of M&M Finance’s business still relies on the parent’s performance. Improved domestic sales by M&M may be a key upside. M&M utility vehicles and tractor volumes grew by 44 per cent and 27 per cent respectively for the quarter ended September 30, 2009 which indicates strong automobile growth.

Strong presence of M&M Finance in the northern region where mechanisation has made greater progress and where reliance on irrigated land is higher, may shield the company’s books from higher slippages.

Wariness of banks and other institutions in lending to tractor and pre-owned vehicle buyers gives the company access to high-yielding assets. The company expects a15 per cent annualised growth for auto financing loans during 2008-12, which may well be achievable as the economy revives and private consumption (cars and utilities) and investment (tractors and CVs) improves. Any rise in interest rates may lead to higher slippages for the company which may put pressure on the spreads, going forward.

via BL