M&M Financial Services banks on H2 recovery and strong valuations

Even as the management guidance remains optimistic, Mahindra & Mahindra Financial Services faced a challenging second quarter (Q2) of 2023–24 (FY24), marked by net interest margin (NIM) compression and a significant increase in credit costs, coupled with higher operating expenditure.

However, the management anticipates a boost in festival season sales, robust rural cash flows, a stable market share, and a diverse product portfolio, which are expected to result in over 20 per cent growth for the year, with a rebound in the second half (H2).

The portfolio mix is projected to shift towards higher-yielding pre-owned vehicles and tractor financing. NIM is set to recover from the current 6.5 per cent to 6.8 per cent by the fourth quarter of FY24, thanks to planned lending rate hikes, an uptick in higher-yielding product growth, and the conversion of interest-free trade advances (worth about Rs 5,000 crore) into retail loans.

Assets under management growth, adjusted for short-term dealer advances, was 23 per cent year-on-year (Y-o-Y).

The management expects credit costs for the year to range between 1.5 per cent and 1.7 per cent, despite hovering around 2.6 per cent in the first half. This significant reduction will be driven by more efficient collection of Stage 3 assets, with a moderation expected in the level of write-offs.

In Q2FY24, net profit plummeted by 48 per cent Y-o-Y, while core profit before tax increased by 10 per cent Y-o-Y. This miss was largely due to higher provisions (up by 216 per cent Y-o-Y).

Net interest income growth was only 10 per cent, despite a 27 per cent increase in loans, owing to NIM compression (down by 44 basis points (bps) quarter-on-quarter (Q-o-Q) and down by 115 bps Y-o-Y) caused by a rise in funding costs (11 bps Q-o-Q and 86 bps Y-o-Y) and a shift to prime customers.

Operating expenses rose by 8 per cent Y-o-Y, and credit costs were higher at 2.8 per cent due to substantial write-offs and a 6 per cent Q-o-Q rise in Stage 3 loans (12 per cent Q-o-Q rise before write-offs). The expected credit loss (ECL) coverage remained stable at 4 per cent.

Loan-loss provisions of Rs 630 crore were up by 19 per cent Q-o-Q and 2.2x Y-o-Y. Approximately 44 per cent of the provisions were attributed to the increase in ECL coverage, while the rest constituted write-offs.

Stage 2 and Stage 3 assets decreased to 5.8 per cent and 4.3 per cent, respectively, from 9.7 per cent and 6.7 per cent in Q2 of 2022-23, and 6.4 per cent and 4.3 per cent in the first quarter of FY24.

Q2FY24 experienced an extraordinary (estimated at about 10 bps) impact on dealer finance that might reverse in the third quarter. However, the cost of funding may rise due to an impending repricing based on the marginal cost of funds based lending rate and the refinancing of low-cost non-convertible debentures.

The company has indicated potential reversals from some slippages, leading to reduced credit costs. This could be achievable given the highly seasonal nature of the vehicle financing business, with a focus on rural areas. Management attributes many of the slippages to delayed payments caused by erratic monsoons and is confident of recovery in H2.

The stock experienced a sharp correction, dropping by 11.5 per cent. This could render valuations attractive, especially when accounting for the seasonal nature of the business and assuming no macroeconomic deterioration. Some analysts are setting targets in the range of Rs 310–330.