Strong topline growth and robust outlook as rural consumption buoyancy sustains but margins narrow sharply.
 
Rising crop prices, good yields and enhanced rural income from various infrastructure projects has buoyed rural demand, which explains last year’s strong loan growth and robust outlook for Mahindra & Mahindra Financial Services.
 
Robust rural cash flows are also manifested in higher cash purchases – up from 10-12% historically to 25-30%, loan to value ratio reducing from 75-77% to 60-65% presently and portfolio quality improvements with lower slippages.
 
The company saw a 62% year-on-year (y-o-y) increase in disbursements to nearly Rs 14,420 crore in FY11. While this frenetic pace is hard to sustain, the management indicates 35-40% growth in FY12 will not be a challenge. The traditional product segments (tractors, Mahindra Auto and Maruti cars) have grown about 22% y-o-y while the newer segments (commercial and construction vehicles, pre-owned vehicles and other cars) have spurred the growth at 40% y-o-y (over a low base) and an expansion in this portfolio is seen as a key focus area going ahead.
 
Standalone gross margins contracted about 90 basis points (bps) y-o-y to 12.1% y-o-y, as total income to assets compressed 110 bps to 17.9%, ascribed to product mix change to lower yielding commercial and construction vehicle financing. Higher overhead costs on strong branch expansion and employee addition was countered by portfolio quality improvements with credit costs down 130 bps y-o-y to 1.4% of average assets despite additional standard asset provisioning as per recent RBI mandate. PAT increased 34% y-o-y to Rs 463 crore in FY11.
 
System-wide funding costs pressures impacted interest spreads in FY11. Cost of funds increased 220 bps to 9% y-o-y against 80 bps yield improvement to 18.5%. Sequentially, costs hardened 40 bps (9.2%) against a 30 bps improvement in yields (18.3%). Management expects a policy rate hike of 50 bps in FY12 but doesn’t expect to fully pass through to the borrower which may impact margins. However, a 50 bps lending rate hike this quarter would alleviate some of the cost side impact.
 
With the strong topline growth outlook, the stock trades at about 2.5x consolidated FY12 book (2.7x standalone FY12 consensus BVPS estimates).