>MAHINDRA & MAHINDRA FINANCIAL SERVICES (FINQUEST)

We interacted with the management of Mahindra & Mahindra Financial Services Limited. The
key takeaways of the meeting are as under.

Disbursement growth
The disbursements are expected to grow at a CAGR of 20% over FY09-FY11E. This would be driven by revival in the auto segment (MoM growth in auto numbers) and relatively stable interest rates. Additionally, the several schemes launched by the government for rural India and the higher budgetary allocations towards the farm segment are likely to fuel demand in rural areas.

Spreads/ Margins
MMFSL is suitably placed between the money lenders and organized players like banks which has contributed to lesser competition and better yields (compared to urban areas). Presently, the tractor segment has the highest average yields of 20-24% followed by CV (avg yield 20%) and UV segments (avg yield ~18%). Going forward management expects to maintain spreads of ~11%.

Funding Mix
NCD's/ Debentures will continue to be the major source of funding for the company whereas the dependence on securitization will come down. According to the management, the company would restrict securitization to 15% of the funding mix in-order to improve balance sheet growth.

Asset Quality
NPA's have increased significantly (GNPA at 9.8% in Q1FY10) in the last 2-3 years led by the defaults from the tractor and CV segments. MMFSL follows aggressive provisioning policy (provision coverage of ~70%) thereby capping net NPA's at ~2.5% levels despite increase in slippages. However, considering the very nature of business, the gross NPAs are expected to remain high.

Capital adequacy
MMFSL maintains high capital adequacy ratio of 18.8% (tier I CAR of 17.2%) against the minimum requirement of 12% by RBI. Management plans to maintain CAR above 14% which leaves significant room for expansion of business.

Valuation
The company's asset quality risk is already priced due to aggressive provisioning policy. Currently the stock is trading at 1.6x FY10 ABV, a significant discount to Shriram Transport finance. We believe that MMFSL will make ~17% RoE's by FY11 (15.4% in FY09) led by strong earnings growth and should trade at 1.7x FY11 ABV. We initiate coverage with a target price of INR 275.

Concerns
MMFSL growth is dependent upon the growth of the parent company (M&M) as 60% of the vehicles financed are M&M vehicles.

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