M&M Financials Services' Q3FY19 results (Outperformer) - A wide miss but strong NII and lower NPLs are key positives

Q3FY19 result highlights

• PAT at Rs3.2bn was 20% below our expectation. It declined 20% yoy and 16% qoq. The miss was on account of a very high tax rate (as tax was paid on income reversals in 2Q) and a sharp increase in opex. AUM growth, NIMs and asset quality were strong. 
• Disbursements grew strongly at 33% yoy and 22% qoq. AUM growth was also strong at 30% yoy and 6% qoq.  CV growth was particularly strong at 71% yoy and 20% qoq followed by strong growth in tractors and cars. CV growth has been exceptionally strong and accelerating since 4Q18 driven by infrastructure demand.
• Despite a tough liquidity environment, NIM remained strong declining only 10bp qoq and 30bp yoy to 8.1%. NII grew 20% yoy and 3% qoq.
• Opex grew sharply by 37% yoy and 17% qoq. Even excluding one-time ex-gratia and silver jubilee payouts of Rs200M, opex growth was high at 31% yoy and 9% qoq. The CEO explained that there could be some lead-lag in opex versus AUM growth and it would take 6-12 months for the new branches to break-even. The company has added 881 employees and 17 branches in 3Q. Due to higher opex, PPOP growth was subdued at 2% yoy and declined 5% qoq.
• Asset quality improved further with GNPAs declining 10% qoq to 7.7%. Slippage for the quarter was Rs4bn. Due to write-offs of Rs9.85bn, provisioning cover declined from 35% to 27% qoq.
• The tax rate of 39% rose sharply from 31% qoq as the company provided tax on prior quarter’s (2QFY19) income write-backs. We note that in 2Q tax rate was lower than normal, the reason for which is now clear. Tax rate will normalize in 4Q.
• Mgmt continues to guide to 20% AUM growth, stable NIMs and sustained improvement in asset quality. Mgmt explained that while outlook for OEMs and conversion of dealership footfalls into sales is subdued, strong rural demand and higher market share for MMFS given its strong network and liquidity position will serve as offsets. 

Valuation and view

Quarterly earnings for MMFS that had shown volatility over the last six years had stabilized over the last 3 quarters. With the big PAT miss in 2Q, volatility has come back which is a negative. However the stock price has already corrected by 11% over the last month. We maintain OP driven by strong AUM growth and improving NPLs. We cut earnings to build higher opex and cut TP to Rs550 (2.8x PBV FY20E).