M&M Financials Services' Q3FY20 results (Neutral) - Core profit better than expected but macro remains tough

Q3FY20 result highlights

• MMFS’ PAT of Rs3.7bn grew 15% yoy and 45% qoq and was in line with the consensus estimate of Rs3.4bn. PBT contains two one-time charges 1) Rs940M of additional provisions on existing NPLs where chances of recovery are inferior to others 2) Rs350M of indirect tax charges (under dispute) through the opex line. Ex these two charges, PAT would be higher than consensus. Core profit was better than expected as NIMs improved qoq and opex was contained.
• Disbursals remained under pressure declining 4% yoy. However qoq growth in disbursals was strong at 31% given the festival season.  Except for auto/utility vehicles and pre-owned vehicles, disbursals for all segments - CVs, SMEs, tractors - declined yoy. AUMs grew 16% yoy (4% qoq). Strong growth in pre-owned vehicles, tractors and cars drove growth in AUMs.
• NIM remained improved 10bps qoq but declined 40bps yoy. NII grew 13% yoy / 7% qoq. The improvement in NIMs was led by decline in cost of funds and higher proportion of used vehicles. While cost of funds declined, the company did not cut lending rates.  The company does not see any scope to increase yields due to weak demand. However, it would maintain them at current levels despite reducing funding cost. Opex moderated after many quarters of high growth due to stringent cost control. Adjusted for indirect tax provisions (currently under dispute), opex grew only 1% yoy.
• Credit cost of Rs4bn grew sharply by 77% yoy / 11% qoq. The company made higher specific provisions of Rs940M on existing stage 3 loans (NPLs) based on management’s assessment that chances of recovery in these loans are inferior to others going by their payment track record.  The LGD was reviewed in December and rose from 29.2% to 30%. Next review in June 2020.
• GNPL ratio on business assets rose 60bps qoq to 8.5% with most new NPLs coming from the CV segment. ECL cover on stage 3 loans rose sequentially from 19.5% to 22.9% due to higher provisions. Mgmt believes that recovery in 4Q would be as good as in previous years due to both crops being good. Mahindra Rural Housing’s NPLs continue to remain high due to high NPLs in Maharashtra.
• Guidance 1) Credit demand will remain subdued for the next few quarters given weak macro / low infra spends while NIMs would stay stable. The company continues to push used vehicles. Supply for new BS IV vehicles will decline significantly in Feb/March. Growth outlook is subdued as the BS-VI demand has not picked up yet. 2) Mgmt believes that recovery in 4Q would be as good as in the previous years due to both crops being good. However lower infra spends are a negative.

Valuation and view

With subdued growth outlook, we maintain Neutral. Given the company’s strong credit rating and good liquidity in a weak sector, it deserves a higher multiple than other NBFCs. We increase our FY20 earnings by 5% and FY21 by 11%. We raise TP to Rs385 from Rs285 earlier based on 1.7x PBV (1.4x earlier).