M&M Financial: Recovery a few quarters away

While monsoon is better than expected, sustained improvement in rural economy is key to company's prospects

The Mahindra & Mahindra Financial Services (MMFS) stock, which had fallen 13 per cent in the first fortnight of June, has rallied about five per cent in the past two trading sessions. While the fall can be attributed to the worries over a weak monsoon, the rally is because early monsoon has been 13 per cent higher than normal, according to the latest data by the India Meteorological Department (IMD). The market’s reaction is not without reason given that 90-95 per cent of MMFS’ branches are in rural and semi-urban areas, making it a direct play on monsoon in the banking and financial services sector. A good monsoon will lead to improved credit off-take and might ease the stress on asset quality. Another reason contributing partly to the rally is that the MMFS scrip has under-performed the Sensex significantly over the past year on rising asset quality stress and slowing assets under management growth. The stock now trades closer to its historical average one-year forward estimated price/book of 2.6 times and appears inexpensive.



“MMFS’ inherent business franchise remains robust and would be manifested again when the rural economy starts turning around. By FY17, we expect return ratios to improve underpinned by acceleration in asset growth, recovery in NIMs (net interest margins) and moderation in credit cost,” says Rajiv Mehta of IIFL. Mehta, who believes the stock valuation is quite reasonable considering the impending sharp recovery in profitability, has an ‘accumulate’ rating on MMFS with a target price of Rs 319.

However, even if monsoon is normal, the MMFS management believes recovery in credit demand and asset quality is still two or three quarters away. While analysts have mixed views on MMFS given the uncertainty around monsoon, their average target price of Rs 286.3 is 15 per cent higher than current levels of Rs 250.

“If there is a good monsoon, MMFS will see good collection from customers and maybe a couple of good quarters. However, rural demand is still under pressure and monsoon is not the only solution. Improvement in rural incomes is a pre-requisite to sustainable financial performance of MMFS,” says Digant Haria of Antique Stock Broking. He has a ‘hold’ rating on the stock and believes given reasonable valuations stock can give 10-15 per cent returns in the near term. Hence, investors can consider it for short-term gains. For now, analysts are closely watching the monsoon trends, clarity over which will emerge by mid-July.

 

On the business front, the company expects assets under management (AUM) growth to be between 10 and 12 per cent in the current financial year and it believes tractor sales will revive in the second half of the year. On asset quality front, the pain might continue in the near term. Also, in order to comply with revised guidelines, MMFS will start classifying bad loans as gross non-performing assets (NPA) if they delay payment by 90 days versus 150 days earlier. This means, the company's gross NPA could be up by 75-80 per cent in the next two quarters. The management, though, has changed its loan origination terms and aims to restrict increase in gross NPAs to 40-50 per cent. Falling base rate of banks, however, will have a favourable rub-off effect on MMFS' net interest margin as bank loans form 49 per cent of the company’s total funding.