Buy Mahindra Financial Services; target of Rs 393: Motilal Oswal

Mahindra & Mahindra Financial Services’ (MMFS) 1QFY17 PAT declined 2% YoY and 77% QoQ to INR0.9b (44% below our estimate of INR 1.56b). Asset quality too deteriorated sharply during the quarter. While 1Q is a seasonally weak quarter, the sequential deterioration was much worse this quarter, with GNPLs inching up 270bp QoQ to 10.7% (the highest increase in a decade). However, given good monsoons and pick-up in economic activity, management expects performance to turnaround in 2HFY17. AUM grew 10.9% YoY (and 1.8% QoQ) to INR417b. The product mix was fairly unchanged QoQ. While growth in car financing picked up impressively (+14.8% YoY), continuing the upward trend of the past few quarters, growth in tractor financing continued to remain sluggish (3.9% YoY). NIM on AUM contracted a sharp 110bp YoY (and 360bp QoQ) to 7.1%. While CoF declined ~40bp YoY, loan yields were down ~160bp YoY. The quarter saw pressure on yields as growth was driven by lower-yielding products like CV, CE and SME, and due to INR1.3b of interest reversals on mounting GNPAs. Other highlights: Provisions made during the quarter declined 30% YoY to INR2.25b. However, in 1Q, the company reversed provisions of INR1.92b made on some loss assets (more than 24 months overdue), for which the estimated realizable value of collateral exceeded net NPA. Without the reversal, the company would have incurred pre-tax loss of INR580m v/s PBT of INR1.34b.

Business environment for MMFS continues to remain weak. While its reported NPLs are likely to remain high (due to rural stress and change in NPL norms), we view this as a cyclical adjustment and not a structural breakdown. The company’s long-term prospects remain strong as stabilization of the rural economy (led by good monsoons) and asset quality, volume pick-up and margin expansion should drive earnings upgrade. We are decreasing our FY17/18 estimates by 3% each to factor in higher credit cost. The stock is trading at 2.7/2.5x FY17E/18E P/B and 23.1/17.7x FY17E/18E P/E. We thus maintain our Buy rating with a target price of INR393 (3x FY18E P/B).