Hope floats in hinterlands

PENNY WISE

Growth rate is high but rural vagaries pose a threat to M&M Financial Services.

"India lives in its villages." This saying of Mahatma Gandhi several decades ago still holds water. India Inc can vouch for the fact as rising disposable income of desi farmers and a saturated urban market are forcing corporates to walk the hinterlands. If FMCG companies were the first to seize the opportunity, banks and NBFCs lost no time in joining the bandwagon.

According to economic think-tank National Council of Applied Economic Research, while rural consumers are likely to continue to account for about 60 per cent of total stock of low-cost items such as bicycles and wrist watches, rural share in demand for high value items such as motorcycles and automobiles is expected to increase in future (see graph on rural share in demand).

Mahindra & Mahindra Financial Services (MMFSL), a subsidiary of the tractor and UV manufacturer Mahindra and Mahindra, is also chanting the rural mantra. As part of its strategy, the company is entering the primary market to raise funds to push its loan assets growth.

The company plans to offer two crore equity shares in the price band of Rs 170-200. Fifty per cent of the issue is offer for sale by its promoter, M&M, and rest is a fresh issue.

Post issue, M&M's holding will come down from 89.78 per cent to 67.7 per cent. The company's capital adequacy ratio (CAR) is expected to go up from current 17 per cent to 19 per cent post issue against 12 per cent stipulated by the RBI for NBFCs.

However, its CAR is far lower than its peers in FY05 such as Bajaj Auto Finance (24.9 per cent ), Cholamandalam Investment Finance company (17.28 per cent ) and Sundaram Finance (14.7 per cent).

The stock trades at a price to adjusted book value of 4.3 times (pre-issue) as on January 2006 and 2.7 times for FY07E. There is a mixed response from analysts regarding the issue pricing.

Some say the pricing is a bit aggressive and any significant upside going forward is unlikely to happen in the medium term. While others say, though the issue is a bit costly, long-term investors can definitely subscribe to the issue as the company caters to a niche market and has wider reach and ready market for its products.

MMFSL is into vehicle financing (tractor, UVs and cars), mainly from M&M portfolio, in rural and semi-urban areas and has close to 4.3 lakh customers through 295 branches.

According to an analyst, "The company's biggest strength lies in its large network of branches unlike its peers. There is also an opportunity in future for tying up with banks by having access to the bank's cheap funds and for sharing revenues owing to the company's reach."

To further expand its reach, MMFSL has tied up with Hindustan Petroleum Corporation Ltd to vend loans and payment services at select pumps across its 6000-station network.

Financing M&M vehicles constitute around 70 per cent of its total loans while the rest is through non- M&M vehicles mainly passenger cars of Maruti, Hyundai, Toyota, Tata Motors, General Motors and Ford.

The company is expected to benefit from the business of M&M as it is the market leader in tractors with a market share of 25 per cent in FY05 and the tractor industry has grown at CAGR of about 20 per cent in last two years.

Also tractor finance is considered as a priority sector by the RBI and almost all tractors are financed owing to lower interest rates, easy repayment and longer tenure of finance. Further, higher GDP growth and improved agricultural production are only expected to fuel further demand for tractors.

In the past, the company has reported decent numbers. It has posted an asset growth of 42.6 per cent CAGR in FY01-05 and even higher growth of 50 per cent in FY03-05.

Total income and net profit rose 28.3 per cent and 36.5 per cent respectively in FY03-05. While sound numbers would create an appetite of a prospective investor, there are also certain risks involved.

If the economy slows down, sales of automobiles will be hit as both are directly correlated. Thus the company's business growth can go for a toss. Its high dependence on business growth of M&M could worsen the problem.

The company operates in a scenario wherein banks, who have cheaper resources and larger branch networks, are all fighting for a higher share in retail finance.

According to analysts, "The company has biggest threat from private banks such as ICICI bank who is very aggressive in retail financing." Thus because of this, its gross spreads could be under pressure. They have already been coming down since FY03. 
 

NPA/SPREADS
%	Net NPAs	Gross spread
FY03	2.80	12.90
FY04	3.70	12.00
FY05	3.20	10.70
DEC-04	4.50	9.90
DEC-05	3.70	8.70

In a rising interest scenario, the company's interest margins could be under pressure. Rising rates could also impact demand for tractors adversely. However Ramesh Iyer, managing director of MMFSL, says, " If the borrowing costs increase substantially, the company can pass on the rise to customers as it operates in a niche market unlike car financing."

The company extends credit based on information furnished by customers. However, assessing creadit worthiness in semi-urban and rural areas isn't easy. Further since its business mainly comprises tractors, the loan asset growth and quality of loans hinge on agricultural growth and farm income, which in turn is dependent on monsoon.

Higher assets growth has given rise to higher NPAs, which was 3.7 per cent of total assets in December 2005 at Rs 158.4 crore against 3.2 per cent in FY05.

Iyer says, "Eventual credit loss is just 1.2 per cent in December and industry average for our kind of business model won't be different. Moreover, historically net NPAs has been below 2 per cent." Its peers namely Cholamandalam and Sundaram Finance had net NPAs of 1.2 per cent and 0.45 per cent respectively in FY05. 
 

FINANCIALS
Rs crore	9 months ended		% change	FY05
	FY06	FY05
Interest earned	366.01	260.24	40.64	377.00
Interest expenses	147.91	89.23	65.76	128.37
Net interest income	218.10	171.01	27.54	248.63
Gross spread	8.70	9.90	-	10.70
Net profit	61.07	52.94	15.36	82.27
NPM(%)	24.39	28.02	-	29.77
EPS	8.66	7.54	14.87	13.20

In nine months ended FY06, total income grew by 43.2 per cent year on year to Rs 398.3 crore and net profit increased by 15.4 per cent at Rs 61 crore. Its asset size of Rs 4,335.8 crore in nine months ended FY06 has crossed FY05 asset size of Rs 3,112.2. However the company's gross spread was under pressure as it declined by 120 bps to 8.7 per cent.

To overcome its dependence on vehicle loans, the company is expected to expand its basket of offerings. Personal and home loans, selling mutual fund and insurance products through its subsidiary are just some of the new strategies in place.