Mahindra & Mahindra Finance

Sturdy business model; brisk growth over FY10-13 Mahindra & Mahindra Financial Services Ltd (MMFSL), a subsidiary of M&M is one of the leading vehicle financing NBFCs in India with an AUM of Rs267bn. It has one of the largest rural and semi-urban distribution franchises comprising 657 branches across 25 states and 4 UTs. Starting as a captive finance company for M&M products, the company has evolved into a diversified vehicle financier. MMFSL's localized business model and nimble loan processing lends it with a strong pricing power. During FY10-13, MMFSL witnessed robust AUM growth and sharp improvement in assets quality driven by rural upswing and structural factors such as network expansion, conservative LTV/loan tenor, robust credit appraisal/monitoring and strong collections engine. Asset and earnings growth to slow but remain impressive In view of deep macro slow down and waning momentum in rural consumption, moderation in MMFSL's disbursement growth is likely to accentuate in FY14 (~18% v/s ~22% in FY13) before recovering marginally in FY15. The deceleration in disbursements would translate into moderated though respectable asset growth of 23.5% pa over FY13-15. MMFSL's NIMs are favorably placed in a declining rate environment and therefore would remain firm despite increase in competition. Delinquencies could show an uptick and along with migration to 120-day NPL recognition should drive a material increase in credit cost in FY14/15. Consequently, earnings growth is estimated to decelerate to 18-20% over FY13-15. Valuation is not cheap but can remain so; initiate coverage with BUY MMFSL's premium valuation amongst NBFCs (2.7x 1-year roll fwd P/BV) is likely to sustain aided by better earnings growth and RoA delivery. Diversified business compared to other vehicle financiers and strong relationships with manufacturers lend higher predictability to MMFSL earnings growth. Key risks to our hypothesis would be a negative surprise in asset growth and asset quality. Initiate coverage on MMFSL with a BUY recommendation and 12month target price of Rs283 which includes forecasted value of Rs12.5 for insurance broking business and Rs4 for rural financing business.

Mahindra & Mahindra Financial Services Ltd - a leading vehicle financing company in India Mahindra & Mahindra Financial Services Ltd (MMFSL), a subsidiary of Mahindra and Mahindra Limited (M&M), is one of the leading non-banking finance companies in India. It has a strong distribution network of 657 offices, covering 25 states and 4 union territories, specially catering to rural and semi-urban areas. MMFSL is in the business of financing purchase of new and pre-owned utility vehicles, tractors, cars, commercial vehicles, construction equipments and SME Financing, and had an AUM of Rs267bn at the end of FY13. About 98% of the asset portfolio is vehicle financing, of which, ~91% is new vehicle financing and residual ~7% is used vehicle financing. Company has entered into over 2.5mn vehicle finance customer contracts since inception, of which, ~1.3mn are active currently. SME financing, started a couple of years back to finance M&M suppliers, is less than 2% of assets with the book standing near Rs4.5bn. MMFSL commenced operations in 1993 as a captive finance company for M&M products that had significant market in rural and semi-urban areas. Post 2002, after gaining substantial share within M&M vehicle sales, company started financing noncompetitive products of other manufacturers to expand operations. This led to creation of new business segments such as car financing, commercial vehicle/construction equipment financing and pre-owned vehicle financing. MMFSL's strong foothold in semiurban and rural areas made it the preferred choice for auto manufacturers like Maruti that was planning to expand its sales in the hinterlands of the country. Currently, MMFSL is the second largest financier of Maruti vehicles, probably the largest in rural areas. Since a few years, company has also been financing competing products such as UVs and Tractors of other manufacturers. MMFSL through its direct marketing initiative is strengthening relationships with non-M&M dealers. This evolution of the company has significantly strengthened MMFSL's business by reducing concentration to products thereby making its growth de-risked and resilient. Presently, the non-M&M portfolio comprises ~50% of assets financed. MMFSL has built a strong brand reputation in rural and semi-urban areas with its customer- oriented business model, diverse product offerings and deep presence.

Group Structure

Mahindra & Mahindra Ltd

51.20% Mahindra & Mahindra Financial Services Ltd

85.00%

87.50%

49.00%

100%

Mahindra Insurance Brokers Limited (MIBL)

Mahindra Rural Housing Finance Limited (MRHFL)

Mahindra Finance USA LLC (JV with Rabobank Group subsidiary)

Mahindra Business & Consulting Services Private Limited

Niche business model built on strong tenets; no significant threat of competition MMFSL positioning of being nimble than a bank and cheaper than a money lender has given expression to aspirations of millions of vehicle owners in the rural and semi-urban areas. Around 80% of vehicle financed by the company are used for earnings purpose and balance 20% (mostly cars/UVs) for consumption. It is highly interactive lending done by empowered local field officers as customers usually do not have necessary documentation supporting their creditworthiness. Therefore, the local field officers need to have strong knowledge about that particular region, crops/yields, other economic activities, customers, etc and should be well-versed with the local language. Loan sanctions are done at branch level with the joint decision of branch manager (who cross examines the field officer about his evaluation of the customer) and branch accountant (who handles KYC and loan documentation and may also call customers for identity verification). Business underwriting is done on strong principals of tight control on LTV and tenor. Average tenor of loans is around two years for used vehicles, three years for cars/UVs and four years for tractors and MHCVs. Further, the company does not restructure installments or the loan. Field and branch officers are interchanged every 12-15 months to ensure internal discipline and to avoid any kind of fraudulent

lending. Branches cannot sanction more than one loan per family and such requests require approval of higher authority. The field officers also collect the monthly instalments from the clients and they are provided with handheld devices which has all the information of their customers and which also prints receipts for the cash collected. Currently, 65% of the collection is in cash form; it used to be around 8085% before the introduction of Car/CV financing. Through the handheld devices, branch and the central office can keep track of all the loans on a real-time basis. MMFSL has brought in various innovations into the business to improve operational efficiency, strengthen customer relationship, deepen its market insight, enhance profitability and effectively compete with other players in the market. It offers a fast turnaround of two days compared to 5-6 days for other NBFCs and 10-12 days for banks. Many private and public sector banks are rapidly growing their rural branch network to tap rural financing opportunities and achieve their financial inclusion and PSL targets. Nonetheless, quick disbursement, relatively lower documentation and flexible repayment options gives MMFSL an edge over banks. Competition from other NBFCs like Shriram Transport Finance, Sundaram Finance, Magma Fincorp etc is insignificant currently given their different product strategy and regional focus. Even if competition from them intensifies, the market opportunity is large enough for all players to grow.