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Mahindra Finance rated ‘Buy’; Q2 Results were better than estimates

Q2 PAT rose to Rs 3.8 bn, a 33% beat vs. our estimates due to higher NIM and lower credit cost. Asset quality surprised positively. We lift FY19-21e EPS by 1-9%. We reiterate Buy as (a) rural fundamentals are positive; (b) MMFS is well positioned to navigate through tighter liquidity; (c) it may partly pass through higher funding cost; (d) asset quality should improve further. EPS growth should be strong and RoE should expand. At 2x FY 20e BV, valuations appear attractive.

Q2 PAT well ahead of expectation
Q2 PAT was Rs 3.8 bn (Q2 FY17 Rs 1.6 bn), well ahead of our Rs 2.87 bn estimate as per Ind AS (GAAP Rs 3.9 bn). The beat was driven by (a) stronger loan growth; (b) better NIMs and (c) lower provision.

Loan growth surprises positively
Loan (net of provision) rose 26% y-o-y to Rs 554 bn (gross loans Rs 588 bn +24% y-o-y). Disbursal grew 44% (off low base) led by tractors, PV, CV/CE. Better rural demand, deeper penetration and market share gains have contributed to strong growth in Q2. Festive season demand has been subdued as has demand in Maharashtra so far. Demand could improve in coming weeks as next phase of festive demand will come from UP & Bihar. We believe positive rural sentiment, improving rural cash flows could support 20% AUM CAGR over FY18-21e despite tighter liquidity related headwinds.

NIMs ahead; expect modest NIM compression
Q2 NIM rose 20 bps q-o-q, as per Ind AS as stronger avg. yields offset higher funding costs (20 bps q-o-q). Funding costs should rise. Marginal cost of funding for July-Aug was 8.4%, which jumped to 9.0% end Sep post liquidity freeze. Overall funding cost increase should be more gradual. Mgmt expects to pass through part of the increase to the borrower, while it may have to absorb part of the increase. We forecast 40bps NIM compression over FY18-20e.

Liquidity position comfortable
MMFS has positive ALM gap of (a) over 120% in 1M bucket and (b) 20% in less than 1 year bucket. Liability profile is diversified, with banks, NCDs, CPs accounting for 31%, 34% and 14% of borrowings. We believe MMFS is well positioned to navigate through tighter liquidity.

GNPA/S3 assets fell 40bps q-o-q; further improvement likely
Stage 3 assets fell 40 bps q-o-q to 9% (Q2 FY18 12.5%), despite seasonally weak rural cash flows in Q2. Credit costs fell 55bps q-o-q to 1.6% (Jeff est 2.1%). S3 assets at rural housing subs. rose 70 bps q-o-q to 17.4%, due to stress in Maharashtra portfolio.With rural cash flows likely to seasonally improve in 2H post harvesting season, asset quality should improve further in 2H. Credit costs could surprise positively driving RoA expansion.

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