Muthoot Finance. CMP: INR215 TP: INR266 (+24%) Buy

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1 BSE SENSEX S&P CNX 26,654 8,157 Bloomberg MUTH IN Equity Shares (m) M.Cap. (INR b) / (USD b) 85.6/ Week Range (INR) 237 / 152 1, 6, 12 Rel. Per (%) 6/18/18 12M Avg Val (INR m) 49 Free float (%) 25.4 Financials & Valuation (INR Billion) Y/E MAR E 2018E NII PPP PAT EPS (INR) BV/Sh.(INR) RoAonAUM RoE (%) Div. Yld. (%) Valuations P/E (x) P/BV (x) May 2016 Results Update Sector: Financials Muthoot Finance CMP: INR215 TP: INR266 (+24%) Buy Muthoot Finance s (MUTH) reported PAT for grew by 60% YoY and 42% QoQ to INR2.65b (vs. our estimate of INR2b). The strong performance was led by intense recoveries efforts, which was further aided by higher gold prices, thus helping MUTH with recoveries of INR1.5b, resulting in PAT surpassing our estimate by 35%. AUM for the quarter stood at INR243.7b, up 4.1% YoY but down 2.5% QoQ (vs. average of 3% since the last 5 two quarters). The subdued growth can be attributed to much higher repayments (led by focus on recoveries), coupled with higher auctions amounting to INR12b during the quarter. Management has guided for an AUM growth of 10-15% for FY17. Provisions during the quarter stood at INR1.3b, with the sharp rise driven by the management s decision to increase standard asset provisions of 100bp instead of the 50bp earlier, which led to additional provisions of INR1b. While this is not the stated policy, the management has guided for its stance to continue. Net income grew by 56% YoY and 53% QoQ to INR8.8b, despite a growth of 4% YoY in AUM. Higher net income was driven by an improvement of 437bps QoQ in yields to 23.4% on the back of additional recoveries of INR1.5b. Moreover, MUTH has also increased its lending rates and the management has guided for a further increase in FY17. NIM increased by 5pp QoQ to 14.4%. Other highlights: a) Raising of stake in Bellstar MFI will further increase stake to 57% at an investment of INR540m b) Invested INR440m in the housing finance business c) Increased holding in Asia s asset finance from 51% to 58% d) MUTH will foray into the mutual fund business and is awaiting approval from the SEBI. Valuation and view: MUTH is the largest organized player in the gold loan financing sector. With the regulatory environment turning favorable and a turnaround in the economy, we expect the company s growth to resume and its AUM to grow at +17% CAGR over the next 2-3 years. Given that 80% of the company s operating costs are fixed, a rebound in business will lead to optimum utilization of its existing infrastructure. The revival in business and improving return ratios make the stock appear attractive at its current valuation of 1.2x FY18E BV. We are raising our FY17/18 EPS estimates by ~5% in order to factor in the better margins. Maintain Buy with TP of INR266 (1.5x FY18E BV). oq Sunesh Khanna (Sunesh.Khanna@MotilalOswal.com); Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 Exhibit 1: Quarterly performance v/s expectations and deviations for the same Particulars E A v/s Est. Comments Income from operations 12,007 14, Other operating income Total Operating income 12,174 14, One time settlement led to INR1.5b of additional income Other income Total Income 12,210 14, Interest expenses 5,739 5,639-2 In-line Net Income 6,471 8, Operating Expenses 3,205 2, Costs under control Operating Profit 3,266 6, Provisions 197 1, Increased standard asset provisions to 100bps Profit before Tax 3,069 4, Tax Provisions 1,104 2, Net Profit 1,965 2, Strong beat on NII and lower opex Int Exp/ operating inc (%) Other Income / Total Income (%) Cost to Income Ratio (%) Tax Rate (%) E: MOSt Estimates Muted sequential AUM growth led by higher recoveries and auctions AUM for the quarter stood at INR243.7b grew 4.1% YoY and down 2.5% on a sequential basis (v/s average of 3% since the last 5 two quarters). The subdued growth can be attributed to much higher repayments (led by focus on recoveries) coupled with higher auctions of INR12b during the quarter. Management has guided AUM growth of 10-15% for FY17. Net income grew 56% YoY and 53% QoQ to INR8.8b, despite 4% YoY growth in AUM. Higher net income was driven by is due to 437bps sequential improvement in yields on back of additional recoveries of INR1.5b, moreover MUTH has also increased lending rates and management has guided to increase them further in FY17. NIMs have increased 5pp QoQ to 14.4%; after reducing the lending rates for last several quarters, the company has started increasing the lending rates and would increase it further in FY17. Standard asset provisions increased to 100bp; Opex under control Provisions during the quarter stood at INR1.3b, the sharp rise was driven by management decision to increase standard asset provisions of 100bp instead of 50bps earlier, which led to INR1b of additional provisions. While this is not the stated policy, the management guided to continue the stance. Absolute GNPLs increased +11% QoQ to INR7b whereas % GNPLs increased 35bp QoQ to INR 2.88%. However management clarified that out of INR7b of NPLs INR5b are technical NPLs on which interest is fully recovered and will correct in due course of time. CI ratio during the quarter was at 31.8% v/s 48.7% in the last quarter (: 51%). Operating leverage is start is play out as opex to average AUM has been declining for the last 5 quarters. The company would be opening branches over the next 12 months, but would focus on generating higher 27 May

3 business from the existing branches, as the current infrastructure can handle a much larger volume of customers. Other highlights: a) Muthoot opened 14 new branches during the quarter. b) CI ratio during the quarter was at 31.8% v/s 48.7% in the last quarter c) Gold holding per branch decreased to 142tn v/s 145tn in the last quarter. d) Reported RoE was at 15.1% v/s 14% in the last quarter e) Increased stake in Bellstar MFI; would further increasing stake to 57% with an investment of INR540m f) Invested INR440m in housing finance business g) Increased holding in Asia asset finance from 51% to 58% h) MUTH will foray in mutual fund business, awaiting approval from SEBI. Valuation and view Over last three years the gold loan industry has been dragged down by various regulatory pressures. However, with most negatives now waning several regulatory hurdles are behind leading to strengthened practices. The RBI has also acknowledged the systemic importance of gold loan companies. MUTH is the largest organized player in the gold loan financing sector. With the regulatory environment turning favorable and a turnaround in the economy, we expect growth to resume and AUM to grow at CAGR of +17% for the next 2-3 years. Given that 80% of the company s operating costs are fixed in nature, a rebound in business will lead to optimum utilization of the existing infrastructure. The benefits of scale and operating leverage will enable MUTH to improve return ratios here on in. Higher return ratios (RoA of 3% and RoE of over 18%) make current valuation of 1.2x FY18E BV really attractive. The stock trades at a discount to its historical P/B average of 1.5x. We increase our FY17/18 earnings by ~5% to factor in better margins. Maintain Buy with TP of INR266 (1.5x FY18E BV). Exhibit 2: We increase our FY17/18 estimates by ~5% INR B Old Est Revised Est. % Change FY17 FY18 FY17 FY18 FY17 FY18 NII Other Income Net Income Operating Expenses Operating Profits Provisions PBT Tax PAT Loans Borrowings Spreads (%) RoAA (%) RoAE (%) May

4 Exhibit 3: Quarterly Snapshot FY15 FY16 Variation (%) QoQ YoY Profit and Loss (INR m) Income from operations 10,762 10,468 10,522 10,870 11,256 11,226 11,235 14, Other operating income Total operating income 10,876 10,583 10,676 11,003 11,401 11,361 11,383 14, Other Income Total Income 10,920 10,615 10,692 11,018 11,426 11,400 11,412 14, Interest expenses 5,354 5,084 5,292 5,332 5,670 5,652 5,616 5, Net income 5,566 5,531 5,400 5,686 5,756 5,747 5,796 8, Total Opex 2,756 2,891 2,989 2,897 2,816 2,918 2,823 2, Employees 1,523 1,576 1,627 1,578 1,607 1,623 1,582 1, Rent Depreciation and Amrt Others Operating profits 2,810 2,640 2,411 2,789 2,940 2,830 2,972 6, Provisions and write offs ,299 1, Profit before tax 2,730 2,600 2,376 2,573 2,835 2,684 2,898 4, Taxes , ,032 2, Profit after tax 1,802 1,707 1,544 1,652 1,832 1,745 1,867 2, Asset quality (Overall) Gross NPA 3,968 4,549 4,103 5,117 5,195 6,341 6,319 7, Net NPA 3,243 3,824 3,378 4,392 4,443 5,484 5,462 6, GNPA (%) NNPA (%) Provisions , PCR (%) Ratios (Calc) Yields Cost of funds NIMs Spreads Cost income ratio Cost to average AUM AUM related Gold Stock Holding (In tonnes) Avg gold loans per branch (INR Mn) Overall AUM On balance sheet Other details CAR Tier I Tier II Book Value Leverage (x) May

5 Story in charts Exhibit 4: AUM grew 4% YoY to ~INR244b AUM (INRb) YoY Growth (%) Exhibit 5: Avg gold loan/ branch stood INR57m Avg Gold Loans/Branch (INR Mn) YoY Growth (%) (1.0) (6.5) (10.6) (19.4)(20.5)(18.4) QFY14 1QFY14 2QFY14 Exhibit 6: Sequential NIM remain stable Exhibit 7: Operating leverage now playing out (%) NIMs (%) Cost to average AUM (%) QFY14 2QFY14 1QFY14 2QFY14 Exhibit 8: GNPA/NNPA increases increases marginally (%) GNPA (%) NNPA (%) Exhibit 9: Bank borrowing at 38% NCD Term Loans Sub Debt Others QFY14 2QFY14 27 May

6 Exhibit 10: Financials: Valuation metrics Rating CMP Mcap EPS (INR) P/E (x) BV (INR) P/BV (x) ABV (INR) P/ABV (x) RoA (%) RoE (%) 66 (INR) (USDb) FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 ICICIBC* Buy HDFCB Buy 1, AXSB Buy KMB* Buy YES Buy 1, IIB Buy 1, IDFC Bk Buy FB Neutral DCBB Buy JKBK Neutral SIB Buy Private Aggregate SBIN (cons)* Buy PNB Neutral BOI Neutral BOB Buy CBK Neutral UNBK Buy OBC Neutral INBK Buy ANDB Buy IDBI Neutral Public Aggregate Banks Aggregate HDFC* Buy 1, LICHF Buy IHFL Buy GRHF Buy REPCO Buy DEWH Buy Housing Finance RECL Neutral POWF Neutral Infra Finance SHTF Buy 1, MMFS Buy BAF Buy 7, ,631 1, ,631 1, MUTH Buy SKSM Buy Asset Finance NBFC Aggregate Financials *Multiples adj. for value of key ventures/investments; For ICICI Bank and HDFC Ltd BV is adjusted for investments in subsidiaries 27 May

7 Financials and valuations INCOME STATEMENT (INR Million) Y/E MARCH E 2018E Interest Income 10,691 22,841 45,158 53,360 48,920 42,623 48,007 50,952 61,142 Interest Expense 4,745 10,383 23,699 28,194 26,260 21,064 22,577 23,019 27,271 Net Interest Income (Incl Sec.) 5,945 12,458 21,459 25,166 22,661 21,559 25,430 27,932 33,871 Change (%) Other income Net Income 6,148 12,776 21,792 25,677 23,214 22,183 26,173 28,716 34,694 Change (%) Operating Expenses 2,666 4,822 8,059 9,667 10,841 11,533 11,381 12,605 14,062 Pre Provision Profits 3,483 7,954 13,732 16,010 12,374 10,650 14,792 16,111 20,632 Change (%) Provisions (excl tax) , ,007 PBT 3,456 7,612 13,312 15,114 11,936 10,279 13,168 15,255 19,625 Tax 1,180 2,670 4,392 5,072 4,135 3,573 5,072 5,339 6,869 Tax Rate (%) Profits for Equity SH 2,276 4,942 8,920 10,042 7,801 6,705 8,096 9,916 12,757 Change (%) Proposed Dividend 0 0 1,487 1,673 2,230 2,410 2,388 2,975 3,827 BALANCE SHEET (INR Million) Y/E MARCH E 2018E Equity Share Capital 3,010 3,202 3,717 3,717 3,717 3,980 3,990 3,990 3,990 Reserves & Surplus 2,835 10,142 25,540 33,639 38,929 46,855 52,202 58,519 66,645 Networth 5,845 13,344 29,257 37,356 42,646 50,835 56,192 62,509 70,635 Borrowings 52, , , , , , , , ,505 Change (%) Other liabilities 4,718 4,526 10,701 16,000 18,517 22,496 23,107 26,573 30,558 Change (%) Total Liabilities 63, , , , , , , , ,698 Loans 54, , , , , , , , ,056 Change (%) Investments ,083 1,183 Net Fixed Assets 1,329 1,886 2,682 3,030 3,270 2,642 2,274 2,501 2,751 Other assets 7,132 17,288 15,366 25,131 32,351 29,185 18,663 40,872 43,708 Total Assets 63, , , , , , , , ,698 E: MOSL Estimates 27 May

8 Financials and valuations RATIOS Y/E MARCH E 2018E Spreads Analysis (%) Avg Yield on loans Avg Cost of funds Spreads on loans NIMs on AUM Profitability Ratios (%) RoE RoA RoA on AUM Cost to Income Empl. Cost/Op. Exps Asset-Liability Profile (%) Net NPAs to Adv Debt/Equity (x) Average leverage Valuations 2010 Book Value (INR) Price-BV (x) Adjusted BV (INR) Price-ABV (x) EPS (INR) EPS Growth (%) Price-Earnings (x) Dividend Dividend Yield (%) E: MOSL Estimates 27 May

9 Corporate profile Company description Kerala-headquartered Muthoot Finance is a nondeposit taking NBFC and the flagship company of The Muthoot Group. Muthoot Finance has a long and established track record and has been in the lending against gold business for the last 70 years, when Mr M George Muthoot founded a gold loan business in MUTH s gold loan portfolio comprises ~5.5m loan accounts in India, which are serviced through 4,245 branches across 26 states and union territories. Exhibit 11: Sensex rebased Exhibit 12: Shareholding pattern (%) Mar-16 Dec-15 Mar-15 Promoter DII FII Others Note: FII Includes depository receipts Exhibit 13: Top holders Holder Name % Holding Goldman Sachs India Fund Limited 1.6 Birla Sun Life Trustee Company Private Limited A/C 1.4 BARING INDIA PRIVATE EQUITY FUND III LIMITED 1.3 Baring India Private Equity Fund Iii Listed Investments 1.2 Reliance Capital Trustee Company Limited A/C 1.2 Exhibit 14: Top management Name Designation M G George Muthoot Chairman George Alexander Muthoot Managing Director Exhibit 15: Directors Name M G George Muthoot George Alexander Muthoot John K Paul* K John Mathew* George Joseph* Name George Jacob Muthoot George Thomas Muthoot Pamela Anna Mathew Alexander M George *Independent Exhibit 16: Auditors Name Rangamani & Co KSR & Co LLP Type Statutory Secretarial Audit Exhibit 17: MOSL forecast v/s consensus EPS (INR) MOSL forecast Consensus forecast Variation (%) FY FY FY May

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