Mahindra & Mahindra Financial Services Ltd staged a decent turnaround in business in FY22-23, leaving most of the demons troubling its business in the dust. The company has fixed its collections machinery after the regulator banned hiring third party agents last year. It has reduced delinquencies progressively, diversified its loan book, and expanded its franchise and underwriting capabilities.
The result has been the highest-ever net profit in FY22-23, at Rs 1,984 crore. For the fourth quarter, the rural-focused non-bank finance company (NBFC) reported 14 percent year-on-year (YoY) growth in its bottomline on the back of a 50 percent jump in disbursements.
On an asset under management (AUM) basis, Mahindra Finance’s business growth was a stellar 27.4 percent. What’s more is the growth is not a one-quarter wonder, and neither is the profitability. To its credit, the lender has been improving its business metrics steadily for eight straight quarters now. The management has offered a robust outlook for FY23-24 as well.
Analysts are thrilled with the company’s fourth quarter performance and the steady improvement has meant that the stock has outperformed the broad market since January. Some brokerages have increased their earnings per share (EPS) estimate for the lender for FY23-24. Out of 36 brokerages that cover Mahindra Finance, 24 have a buy rating and 10 have a hold label on the stock, a sign that the lender is gaining favour among investors.
That said, the ride has been rather bumpy for the company as well as its stock. In the past one year, the share price has seen two episodes of intense selling — one in July 2022 and another in February. Moreover, brokerages have shown optimism, but are reluctant to re-rate the company. What gives?
“Re-rating prospects are contingent on stable and predictable business/earnings traction and execution,” analysts at Elara Securities India Pvt Ltd wrote in their note.
Earnings volatility bothersome
Mahindra Finance’s biggest drawback has been its rather volatile track record on profitability. Delinquencies have been lumpy and so have provisions. Ergo, the bottomline has swung widely in the past 5-6 years. Investors do not like inconsistency, and this explains why they’re not convinced about the stock yet.
But that is about to change as the management is working towards eliminating volatility. To be sure, some degree of volatility is expected given that the firm operates in a niche segment of commercial, rural, and semi-urban lending. Auto loans and tractor finance are the anchor of its loan book. Even so, analysts point out that provisions should not swing so widely. “While MMFS’ NPA volatility is justified due to its niche earn-and-pay customer focus, the continued erratic provisioning trends seem incomprehensible,” said the Elara note.
Vivek Karve, Chief Financial Officer of the lender, said that going forward the volatility in provisioning would reduce. “In the past when there was volatility in asset quality, that is where you’d find the provisioning to be very erratic. There is now a structural trend in stage 2 and stage 3 assets,” he told Moneycontrol in a telephonic interaction. Karve added that as asset quality stabilises, provisions too would stabilise. Stage 2 assets are those where loans are overdue by 31-89 days, and stage 3 assets are where loans are overdue by 90 days or more.
The lender has been working on this for the past two years. Mahindra Finance is now targeting affluent rural and semi-urban customers that have a higher chance of demonstrating resilience during a crisis. This augurs well for its asset quality. Further, it is diversifying its loan book although vehicle loans will remain a mainstay. The lender will be focusing on loans for pre-owned vehicles, loans against property (LAP), personal loans, and on its leasing business in the coming quarters.
The upshot is that Mahindra Finance is doing everything to improve its asset quality trajectory on a sustainable basis. This is part of the vision 2025 that the company detailed two years ago. As part of the plan, the lender aims to grow its AUM two times the current size, keep delinquencies below 6 percent, maintain margins around 7.5 percent, and keep the operating cost ratio at 2.5 percent. Karve said the company is on track to meet its targets, although the operating cost ratio could prove to be a bit challenging.
Analysts believe that these are notable improvements, but the lender also needs to keep a lid on its write-offs. For the fourth quarter, write-offs rose to Rs 600 crore from Rs 498 crore in the third quarter. Bringing down write-offs is critical for the lender to achieve a reduction in credit costs over time. Jefferies pegs its credit costs to be 1.7-1.9 percent for the next two fiscal years.
Growth antidote
Analysts seem to share the management’s guidance that disbursement growth is one antidote against delinquency ratios. Mahindra Finance is targeting more stable borrowers and customers that have shown resilience during the pandemic. Further, it has isolated troubled loans and decided to avoid such customers in future.
These two measures would help the lender overcome its delinquency issues. It is also chasing secured asset classes such as LAP and collateralised business loans, even as tractor finance remains its mainstay.
The jury is still out on the monsoon, which determines the robustness of the rural economy. That said, so far demand from rural and semi-urban areas for commercial vehicles have held up. The management has guided robust disbursal growth for FY23-24 as well.
The flipside of growth is high operating expenses. This seems to be another irritant for analysts. Mahindra Finance’s operating expenses were elevated in Q4FY22-23 and the company has said they will be so in FY23-24 as well.
“Our disbursements for the year have gone up by 80 percent due to heightened travelling and collection. So, the cost is a function of disbursement growth, not asset growth,” Karve said. “We are in the midst of a transformation project which calls for IT spending. You will see elevated opex for the next one-two years, before it begins to come down,” he added.
More bang for their buck
Mahindra Finance’s progress on asset quality and its plan to fortify its balance sheet further is helping justify the market valuation. According to analysts, the stock is reasonably priced at around twice its estimated book value for FY23-24.
Indeed, investors have been getting more bang for their buck with the steady improvement in return ratios. The NBFC’s return on assets (ROA) climbed 2.3 percent in FY22-23 from 1.2 percent in FY19-20. Return on equity (ROE) has improved to 12.1 percent from 8.1 percent in the same period. Morgan Stanley analysts expect ROE to improve further to 13 percent in FY23-24 and 15 percent in FY24-25. Those at Jefferies peg the FY23-24 ROE at 13-14 percent.
In this context, the stock can be potentially re-rated. However, for that to happen, Mahindra Finance must demonstrate steady asset quality over a longer period. In a nutshell, Mahindra Finance needs to triumph over the test of time in order to convince investors that its balance sheet is well and truly fortified. Its FY22-23 performance is a good start and its efforts to strengthen its balance sheet are bearing fruit.
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