We upgrade MMFS from ‘hold’ to ‘buy’ expecting a cyclical upturn in earnings and asset quality given improving rural macro. Monsoon has been normal so far. MMFS reported strong disbursal growth and improving asset quality trends in Q1. We believe earnings at MMFS could rise 4x over FY 17-20E potentially lifting ROE to over 20% (7.6% FY17), close to prior highs. Valuations appear reasonable in this context despite 13% rally post results. Strong cash flows from last year’s bumper crop and normal monsoon, till date, this year have improved rural sentiment; coupled with higher rural wages, in real terms and potential revival in rural capex could lead to a pick up in rural demand. With 75% of its loans coming from rural areas, MMFS should gain from a potential recovery in rural macro. We forecast MMFS loans to grow at 18% CAGR over FY17-20E, 13% over FY14-17.
MMFS said collection efficiency in Q1 was 95% above 90% collection efficiency seen by MMFS in Q1 in last few years. With rural cash flows improving delinquencies could fall. This could offset potential rise in reported GNPA due to shift to 90 dpd NPA recognition (from 120 dpd). We expect NIMs to rise 68bps in FY18 due to lower income reversal and fall in borrowing costs. MMFS’s credit costs are highly cyclical, 1.1%-3.3% over FY12-FY17, with write-offs accounting for over 50% of provision. Stronger collections, lower write-offs could lead to 96bps decline in credit cost over FY17-19E. We forecast ROA to rise to 2.3%, FY17 1.25% and ROE to rise to 19.3% (7.6% FY17) in FY19.
MMFS indicated that it could raise capital in FY18 to meet its growth requirement, Tier 1 12.9% Q1. Assuming 5% equity dilution at CMP, 3.2x FY17 BV, we estimate EPS could rise marginally by 1%; FY18E BV could rise 17%, Rs 160/share and ROE dilution could be ~200bps. We lift FY18-19E EPS by 4-11% factoring stronger AUM growth and better NIM outlook. Our med-term estimates have increased as well. MMFS is trading at 2.9x FY18E BV, 2.5x FY19E BV, at a premium to historic average, but this should be viewed in context of cyclical earnings and asset quality upturn from FY17 lows. Our new target price of Rs 460 based on RI valuation, Sept 18E vs June 18E before, implies 3.4x FY18E BV, 2.9x FY19E BV.