Retain ‘hold’ on Mahindra Finance with TP at Rs 125

Growth outlook is gradually improving on healthy agri sector demand; other segments likely to follow. Collections improving m-o-m; 5-7% of loans could potentially be restructured, adequate provisions buffer to be created.  Retain ‘hold’, revise TP to Rs 125 from Rs 112 and adjust earnings to reflect better growth, lower opex and recent dilution.  We hosted Mahindra Finance’s management team for investor meetings during our Virtual Financials Tour on 22 September 2020.

The investor discussions mainly concerned two key areas demand revival in a post-Covid-19 world and asset quality outcomes post the moratorium and potential stress in the portfolio. Demand picking up in pockets: Agri demand continues to be strong on the good monsoon and harvest. Government initiatives towards the infrastructure and mining sectors are likely to shore up demand going forward.  Product-wise, tractors, passenger cars and utility vehicles (UVs) are seeing healthy demand.

The company has adopted a conservative approach towards the heavy commercial vehicles (HCV)/construction equipment (CE) segment due to concerns over utilisation.  Demand in the pre-owned segment is currently slow on fewer transactions, which is likely to pick up going forward.  MMFS expects new business overall to reach pre-Covid-19 levels in 4QFY21.

Collections improving but still below normal, Collections improved m-o-m to 80% in August from 70% in July. However, collections for September should draw the true picture. Segments such as cab aggregators, HCV (including passenger buses) and tourist taxis are seeing cash flow stress. MMFS expects 100-150k customers (of the 2m total) to go for loan restructuring, which is about 5%-7% of its overall portfolio. Management plans to continue to build the provisioning buffer proactively.

Return ratios set to gradually improve, notwithstanding the pandemic-led disruption in FY21, improvements in return ratios will likely be driven by the return of growth and utilisation of capital; cost optimisation by achieving 2% cost ratios vs 2.8% in FY20; and a reduction in credit costs.

We raise our FY21e/22e profit by an average of 15% on the fast recovery in rural markets, leading us to raise our growth assumptions, and lower opex. We also factor in the dilution from the recent rights issue, which affects our EPS growth estimates. We revise our target price to INR125 from INR112 earlier. We retain our Hold. Rural India so far has been relatively less affected by the virus, and hence, we expect MMFS to revert to normalcy sooner than later.

However, the asset quality outlook remains uncertain near term and customers’ repayment behaviour post the moratorium and subsequent loan restructuring is yet to be seen. Downside risks: cutbacks in government spending could affect rural demand, and prolonged lockdowns pose threat to asset quality. Upside risks: normal to better monsoon, improving demand and asset quality outlook, and pickup in rural infra and mining activity.