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Limited upside for M&M Financial, L&T Finance

These have been underperforming; firm valuations and growth/asset quality woes likely to keep scrips under check

Sheetal Agarwal Mumbai
The scrips of Mahindra & Mahindra Financial Services (MMFS) and L&T Finance Holdings (LTFH) have underperformed the benchmark Sensex on the BSE in recent months. While a weak monsoon might further spoil the party for the former, the latter is likely to feel the heat of continued weakness in infrastructure financing.

However, both these non-bank financial service (NHFC) companies will benefit from falling corporate bond yields, which will rub-off positively on their cost of funds and  their margins. Even so, firm valuations and muted growth outlook means investors should wait before entering these stocks.

MMFS
In 2013, the MMFS stock had seen a huge run-up on banking licence prospects. It began underperforming once asset quality issues became visible in December 2013, with gross non-performing assets (NPAs) up to four-five per cent versus three-four per cent earlier. And, also after the Mahindra group decided not to apply for a banking license. A large part of MMFS’ book is from rural areas and to that extent, the company is vulnerable to weak monsoons, which could impact the demand for fresh loans and partly borrowers’ ability to service existing debt. About half its loan book comes via funding M&M-branded vehicles. Tractors formed 20 per cent of its loan book in FY14, while cars and auto/utility vehicles formed 22 per cent and 32 per cent, respectively.

The management hopes to restrict the impact of a weak monsoon (led by diversification into non-agri lending) and expects loan growth of 14-15 per cent in FY15 (in FY14, it was up 23.2 per cent and by 37.4 per cent in FY13). The company has also stepped up efforts to push recoveries.

However, some analysts are cautious. “Earnings revisions for MMFS have remained negative since the first half of last year and we do not expect this to turn positive yet. Firm visibility on the outlook might only come once monsoon trends are more firmly established and there is better clarity on the way forward on some large rural spending programmes,” says Saurabh Kumar of JPMorgan.

MMFS’ gross NPAs could worsen, depending on the monsoon outlook for FY15, where we note there are risks lurking, he adds. Analysts expect a 20 per cent compounded annual growth rate in loans over FY14-16 versus a little over 30 per cent in FY10-13. For FY15, it is estimated at 12-14 per cent.

  “We would prefer to wait for risks on monsoons to play out before we get incrementally positive on MMFS. Though non-agricultural use for MMFS customers has increased, the underlying asset quality still remains anchored to rural buoyancy,” says Adarsh Parasrampuria, research analyst, Nomura.

Some other analysts are more positive. “The MMFS stock has under-performed the benchmark on asset quality, monsoon concerns. However, a strong focus on recoveries is likely to offset the potential impact,” says Jaynee Shah, financials analyst at Religare Capital Markets. At current levels of Rs 262, the stock trades at rich valuations of 2.7 times the FY15 estimated book value. Of the 31 analysts polled by Bloomberg since April, 17 have a ‘Buy’, eight a ‘Neutral’ and six a ‘Sell’. Their average target price of Rs 275 indicates meagre gains of five per cent from Tuesday’s closing price.

L&T Finance Holdings
While the macro scenario is weak, LTFH’s cautious approach towards lending had reduced its loan growth from a little over 30 per cent earlier to 20 per cent in FY14. On the other hand, increased pressure on infrastructure and vehicle financing businesses has weakened its asset quality. In May, the management had said it expected loan growth of 15-20 per cent in FY15.

Not surprisingly, most analysts remain bearish on LTFH. Of the 10 analysts polled by Bloomberg since April, six have a ‘Sell’ and the rest a ‘Hold’ rating on the stock. While the stock currently trades at two times the FY15 estimated book value, closer to its historical average one-year forward price/book value, the average target price of analysts at Rs 65 points to a nine per cent downside from the current Rs 72. On asset quality, LTFH’s gross NPAs rose 115 basis points year-on-year to 3.2 per cent in the March quarter. Sequentially, too, the metric increased 25 basis points. Construction equipment, commercial vehicles and corporate and restructured assets pulled down its overall asset quality. The management remains confident on maintaining asset quality, though analysts disagree.

“Asset quality remains a concern, with credit costs/restructuring staying at elevated levels in the infrastructure business. Shares of LTFH are pricey relative to the peer group, especially considering a lower return on equity (11 per cent in the lending business),” analysts at JPMorgan write in a recent report on the company. “However, we believe the market’s expectation of a bank licence fructifying down the road is likely to keep the stock at a premium to fair value.”

The management had indicated after the March 2014 results that it was still keen on a banking licence and would evaluate whether to apply for the promised differentiated or on-tap licence.

The company’s other and smaller business, in housing finance and investment management, posted improved profitability in the March quarter. The company expects to sustain the performance.

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First Published: Jul 08 2014 | 10:47 PM IST

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