Gold Loans. Lending with comfort

Transcription

1 Gold Loans Lending with comfort Muthoot Finance BUY CMP: Rs154 Target: Rs22 Largest gold financing company in the country with 2%+ market share AUM growth to moderate but remain strong on higher base NIM to decline on steep increase in funding cost; yield to be relatively resilient Earnings CAGR to remain brisk at 39% over FY11-13E RoA to marginally come-off; RoE to normalize Manappuram BUY CMP: Rs57 Target: Rs73 Fastest growing gold loan company; 8x AUM growth over FY9-11 New branches to drive 45% AUM CAGR over FY11-13E NIM to contract sharply due to decline in yield and increase in funding cost Earnings CAGR to remain robust at 47% over FY11-13E RoA to trend down while RoE to improve India - a huge gold loan market India is one of the largest markets for gold accounting for ~1% (18,- 2, tons) of the global gold stock. Rural India is estimated to hold around 65% of this. Shaped by sentimental and structural factors, country s demand for gold has been buoyant defying the phenomenal rally in price. It is estimated that ~1% of country s gold stock has been pledged, of which, ~75% is in the unorganized market (money lenders, pawn brokers, etc) and balance ~25% in organized market (specialized NBFCs, other NBFCs, commercial/cooperative banks, etc). Organized market growing at robust pace As per IMaCS Industry Report (21 update), the organized gold loan market in India stood at Rs35-4bn at end-fy1 having witnessed a robust 4% CAGR over FY2-1. We estimate the market to have crossed Rs55bn by end-fy11 as specialized NBFCs Muthoot Finance and Manappuram combine have grown their book by Rs13bn+ during the year. Share of the organized pie has been increasing rapidly due to significantly lower rate of interest charged, higher LTV offered and perceived safety of the ornaments. With penetration still negligible at 1-1.5%, the organized market would continue to witness strong growth. Specialized NBFCs better placed than banks Amongst organized players, specialized gold loan NBFCs have witnessed exceptional growth driven by management aggression/strength, robust branch expansion, belligerent marketing spend and ability to raise capital timely. Given the customers preference for them over banks due to critical factors like low levels of documentation, quick disbursal of loans, higher LTV offered, flexibility in loan terms, etc, specialized NBFCs command premium yields and enjoy superior profitability. Therefore, they represent a much better medium to ride the gold loan growth story. Initiate coverage on Muthoot and Manappuram with BUY rating We initiate coverage on Muthoot Finance and Manappuram with a BUY rating. Both the companies have witnessed 1%+ CAGR in their gross gold loan book over FY9-11. Notwithstanding the substantial business investments made, they have improved their profitability profile. Their dream run is expected to normalize though on account of higher base, intensifying competition in the key Southern region, recent adverse regulation with respect to assignments and steep increase in funding cost. Nevertheless, their earnings CAGR is estimated to be strong in the range of 35-5% thereby making current valuations ( x FY13 P/BV) attractive. Key risk factors would be unfavorable regulatory changes and material correction in gold prices. Financial summary Y/e 31 Mar Muthoot Finance Manappuram (Rs m) FY12E FY13E FY12E FY13E Total operating income 18,37 25,29 13,325 17,755 Yoy growth Operating profit (pre-provisions) 11,22 15,573 7,168 9,687 Net profit 6,891 9,576 4,498 6,16 yoy growth Research Analyst Rajiv Mehta, CFA research@indiainfoline.com EPS (Rs) BVPS (Rs) P/E (x) P/BV (x) ROE ROA CAR June 21, 211

2 Gold Loans India is one of the largest markets for gold accounting for ~1% of the global gold stock Inelasticity in gold demand shaped by multiple structural factors Rural India is estimated to hold around 65% of total gold stock ~1% of the country s gold stock has been pledged for loans Of this ~75% is with the unorganized players such as money lenders, pawn brokers, etc Unorganized players charge exorbitant interest rates and offer lower LTV Estimated more than 1lac money lenders across the country; 4-5% of them in Southern India The share of organized players (NBFCs and Banks) has been increasing rapidly Gold loan market in India India is one of the largest markets for gold accounting for ~1% (18,-2, tons) of the global gold stock as at end-fy1. During 25-1, annual gold demand has been stable at around 7 tons despite a 22% CAGR in gold prices. Indian consumers have an affinity for gold that emanates from various social and cultural factors making their demand for bullion partly price inelastic. Further, the low level of financial inclusion and poor access to financial products make gold the default savings and investment instrument for the country s vast rural populace. Also high liquidity (conversion into cash instantly to meet urgent fund requirements) of gold has been driving its robust demand. Rural India is estimated to hold around 65% of total gold stock. It is estimated that ~1% (1,8-2, tons) of the country s gold stock has been pledged for loans combined in the organized and unorganized markets. The long-operated unorganized gold loan market is huge (accounting for ~75% of the pledged gold stock) and includes numerous pawn brokers and money lenders operating primarily in rural areas. These players have a strong understanding of the local customer base and offer immediate liquidity to borrowers in need without requiring elaborate formalities. However, they charge exorbitant interest rates in the range of 3-5% pa and offer relatively lower LTV (loan-to-value) in the range of 4-6%. It is estimated that there are more than 1 lac money lenders across the country with 4-5% of them present in the Southern states of Andhra Pradesh (~31,), Karnataka (~15,), Tamil Nadu (~13,) and Kerala (~7,). Almost all the money lenders typically use gold as security for lending rarely using any other materials such as household goods, etc in the form of security. The organized market accounting for ~25% of the pledged gold (5 tons) includes specialized NBFCs (pre-dominantly focusing on gold loans), other NBFCs, commercial banks and co-operative banks. The share of the organized pie has been increasing rapidly due to lower rate of interest, relatively higher LTV, safety of the ornaments and other benefits. Annual demand for gold in India 9 (MT) Source: World Gold Council and IMaCS Sector Report 2

3 Gold Loans Organized gold loan market stood at Rs35-4bn at the end of FY1; estimated at Rs55bn+ by end FY11 Substituting traditional players, tapping fresh markets and rally in gold prices have driven the growth of organized market Notwithstanding the growth witnessed, penetration still remains negligible Organized market to continue to grow at robust pace Changing perception of gold loans could drive accelerated adoption by upper middle and higher income groups Organized gold loan market growing at robust pace As per IMaCS Industry Report (21 update), the organized gold loan market in India stood at Rs35-4bn at the end of FY1. Over FY2-1, the market has witnessed a robust 4% CAGR. We estimate organized market to have crossed Rs55bn at the end of FY11 as leading NBFCs, Muthoot Finance and Manappuram have combined registered Rs13bn+ accretion in their gold loan book during the year. Apart from substituting unorganized players and tapping fresh markets (areas/locality), the impressive growth of organized market has been driven by handsome rally in gold prices since 25. During FY5-11, gold prices have witnessed 22% CAGR. The organized gold loan portfolio accounted for merely 1.2% of the value of total gold stock in India as at end-fy1, as per IMaCS Industry Report (21 update). The sheer negligible penetration, aggressive network expansion/marketing initiatives by players and increasing awareness/adoption of gold loans would drive strong growth of the organized market over the next 3-4 years. The only caveat would be a material correction in gold prices. The sustained marketing efforts of specialized NBFCs have been diminishing the stigma attached to pledging gold jewellery and altering the perception of gold loans from an option of the last resort to an option of convenience. Therefore, we believe that market for gold loan products could exponentially grow if there is an accelerated adoption by upper middle and higher income groups. Organized gold loan market Penetration of the organized market (Rs bn) 36 3 Value of Gold stock (Rs tn) Penetration of Org Mkt FY2 FY7 FY9 FY1 FY FY2 FY7 FY9 FY Source: World Gold Council, IMaCS and India Infoline Research Stupendous rally in Gold since 25 24, (Rs/1gm) 2, Returns delivered by Gold each fiscal , , 21. 8, 4, Oct-5 Jul-6 Apr-7 Jan-8 Oct-8 Jul-9 Apr-1 Jan-11. FY6 FY7 FY8 FY9 FY1 FY11 YTD Source: Bloomberg, India Infoline Research Sector Report 3

4 Gold Loans Southern region accounts for ~4% of India s annual gold demand and 85-9% of the organized gold loan market ~7-75% of the branches of specialized NBFCs are located in the southern region Share of southern region has been on decline with these NBFCs expanding aggressively in other regions Operating dynamics of specialized NBFCs and banks are vastly different Banks have enhanced focus on gold loans due to its higher profitability adjusted for lower default rates Specialized NBFCs typically command premium yields and therefore enjoy significantly superior profitability Their NIM and RoA are in the range of 8-16% and 3-5% as compared to 2-4% and 1-2% respectively for banks Branches of specialized NBFCs located closer to banks are witnessing higher customer visits Customer preference for these NBFCs despite their higher interest rates is driven by multiple structural factors Customers are usually in urgent need of funds and therefore are driven by maximum loan exposure and minimum disbursal time Southern India is the largest gold loan market Presently, the southern region of India accounts for 85-9% of the organized gold loan market. The dominance of the region is attributed to its majority share in the country s gold holding and more openness towards borrowing against gold. According to IMaCS Industry Report, south India accounts for 4% of India s annual gold demand, followed by the western region at 25%, northern region at 2-25% and eastern region at 1-15%. Not surprisingly, ~7-75% of the branches of specialized NBFCs such as Muthoot Finance and Manappuram are located in the southern region. More importantly, a disproportionately higher share of business comes from this region manifesting its higher proclivity towards borrowing against gold. Over the past two years, however, specialized NBFCs have started expanding aggressively in the other three regions accompanied by belligerent promotions to enhance awareness. This along with shifting psychographics is likely to drive a gradual decline in southern region s share in the organized gold loan market. Specialized NBFCs better placed than banks The operating dynamics of specialized NBFCs (Muthoot and Manappuram) and banks are vastly different which is reflected in the margins and profitability. For a specialized NBFC, gold loans is the primary business while banks have traditionally viewed gold loans for agriculture purpose as a safer means to meet their priority lending targets. Further, with increase in default rates in some retail segments especially personal loans over the past few years, banks have enhanced focus on gold loans as it offers attractive returns adjusted for low levels of defaults. Recently, RBI precluded gold loans from being classified under the agriculture sector, thereby making such loans ineligible to meet banks' priority lending targets. Specialized NBFCs have invested heavily in building their service offerings and typically command premium yields and attractive profitability. Though interest rate charged varies in the wide range of 12-26%, average yield earned by these players is between 18-25%. Interest rates charged by commercial and co-operative banks are significantly lower varying from 8-13%. Generally, banks also levy processing charges which is not in the case of NBFCs. Resultantly, NIMs of gold loan NBFCs are substantially higher at 8-16% as against 2-4% for banks. RoA of NBFCs is much attractive at 3-5% v/s 1-2% for banks. Our conversations with Muthoot and Manappuram revealed that their branches located near to banks (some even in the same building) are able to attract more customers than latter in spite of higher interest rates. They attribute customer s preference for NBFCs to 1) low levels of documentation and formalities 2) quick approval and disbursal of loans (average turnaround time is 1-15 minutes for a new customer and 5-8 minutes for an existing customer) 3) higher loan-to-value exposure (75% at the higher end as compared to 6-65% given by banks) 4) flexibility in terms of loans and 5) presence of expert valuers. It has to be understood that gold loan customers typically look at minimum disbursal time and maximum loan exposure for their gold as they have an urgent need for funds. Further, since loans are all over-collateralized by gold jewellery, there is minimal requirement for documentation and credit assessment, thereby shortening the response time. Sector Report 4

5 Gold Loans Market share of NBFCs has increased significantly from 18% in FY7 to 32% in FY1 However, commercial banks focused on southern India continue to dominate the market with 58% share NBFC s market share has been increasing at fast clip According to IMaCS Industry Report, the market share of NBFCs in the organized gold loan market has increased significantly from 18% in FY7 to 32% in FY1. On the other hand, other players such as public and private banks and co-operatives have witnessed a material decline in their market shares. However, commercial banks focused on southern India (IOB, SIB, Indian Bank, Andhra Bank, Federal Bank, etc) continue to dominate the market with 58% share in FY1. NBFC s market share gain has been mainly driven by exceptional growth of specialized gold loan companies such as Muthoot and Manappuram. Movement in market share of organized players Public Banks Private Banks NBFCs Co-operatives 1.% 8.% Growth over FY7-1 of organized players % % 15 2.%.% FY7 FY9 FY1 Public Banks Private Banks NBFCs Cooperatives Source: IMaCS and India Infoline Research Growth in loan book witnessed by leading players FY7 FY9 FY1 75 (Rs bn) Muthoot Finance Muthoot Fincorp Manappuram Indian Bank IOB South Indian Bank Andhra Bank Top 5 gold loan providers with market share Gold Loan Book Market Share (Rs bn) Muthoot Fin IOB Indian Bk Manappuram SIB Source: IMaCS and India Infoline Research Sector Report 5

6 Gold Loans Critical success factors for Gold Loan companies Operational risk management Technology, Systems and Processes Reach/Strong distribution network Brand recognition Faster turnaround time Critical success factors for Gold Loan companies Access to low cost of funds Unique and customized product offering Security of Gold as collateral Evaluation of Gold Kerala has imposed its Money Lenders Act on all NBFCs operating in the state proposing an interest rate cap of 18% Its imposition is being challenged by specialized NBFCs in Supreme Court Other southern states have not imposed Money Lenders Act on NBFCs A material portion of AUM growth for gold loan companies was driven by gold price uptrend Therefore, a significant correction in gold prices would have a direct impact on their future growth Adverse regulations could hurt profitability Kerala has imposed its Money Lenders Act on all NBFCs operating in the state that proposes an interest rate ceiling of 18%, substantially lower than 2-24% charged by gold loan companies. The imposition of the Act was later upheld by the High Court and NBFCs such as Manappuram and Muthoot have challenged this decision in the Supreme Court. Their contention is that they are already governed by RBI and interest rate charged is as per the guidelines under the fair practice code. Further, the 7,+ registered money lenders in Kerala are actually charging higher interest rate of 3-4% than prescribed 18%. Tamil Nadu, Karnataka and Andhra Pradesh also have their own Money Lenders Act but have not imposed it on NBFCs. In our view, a perceivable risk could be RBI setting an interest rate and margin cap for gold loan companies as done for MFIs recently. If caps are set at similar levels (26% for interest and 12% for margin), than some gold loan companies (such as Manappuram) would be impacted at the margin level. Correction in gold prices would impact growth Over the past three years, there has been a sustained rally in gold prices having risen from US$917/ounce in FY8 to US$1,432/ounce in FY11 (a 16% CAGR). We believe that a material portion of AUM growth for gold loan companies was driven by the gold price uptrend mainly reflected in improving average ticket size of loans. In the light of persisting global uncertainty, we assume gold prices to be stable over the next two years. However, if there is a material correction in price than AUM growth of the gold loan companies would be directly impacted. Companies would need to add higher number of customers as average ticket size would decline. We believe that impact of sharp decline in gold prices on asset quality would be limited given a comfortable LTV ratio of ~7% and shorter loan tenures. Sector Report 6

7 Muthoot Finance Ltd BUY Dominant player Sector: Financials Sensex: 17,57 CMP (Rs): 154 Target price (Rs): 22 Upside : Week h/l (Rs): 199/154 Market cap (Rscr) : 5,734 6m Avg vol ( Nos): - No of o/s shares (mn): 372 FV (Rs): 1 Bloomberg code: MUTH IN Reuters code: - BSE code: NSE code: MUTHOOTFIN Prices as on 2 Jun, 211 Shareholding pattern May '11 Promoters 8.1 Institutions 6.9 Non promoter corp hold - Public & others 13. Performance rel. to sensex 1m 3m 1yr Muthoot Manappuram 4.3 (2.5) 53.5 M&M Fin (1.9) (1.7) 36.1 Shriram Tran (6.9) (15.6) 2.1 Largest gold financing company in the country Muthoot Finance (Muthoot) is the largest gold financing company in India with a gross gold loan portfolio of Rs15.9bn as at March 211 and a commanding market share (2% in FY1). Company s AUM has witnessed a phenomenal 82% CAGR over the past four years driven by substantial network expansion, significant improvement in branch productivity, sustained rally in gold prices and strong brand recognition. Gold stock has increased from 23MT to 112MT over FY7-11 representing 49% CAGR. About 67% of the current ~2,9 branches are located in the southern region which contribute 74% to the gold loan portfolio. AUM growth to moderate but balance sheet growth to be strong We anticipate Muthoot s AUM growth to slow down to a more normalized 37.5% pa over FY11-13 due to base effect, increasing penetration and competition in South (especially Kerala) and slower adoption of gold loan product in other regions. Further, if the gold rally were to halt, AUM growth would be purely volume driven. With limited incentive for assignments now, bulk of the incremental growth would be reflected on the balance sheet propping up the net loan CAGR to 57.5% over FY Business growth would be mainly driven by significant improvement in productivity of ~1,75 branches added in the past two years. NIM to contract on sharp increase in funding cost Notwithstanding the tailwind from IPO, Muthoot s NIM is estimated to correct by 14bps in FY12 to 9.5% due to steep rise in the cost of funds. The cost of bank borrowings has increased by 15-2bps in recent months on account of lending rate hikes by banks and loss of PSL status for assignments. Any fresh retail secured NCD issuance by Muthoot would likely happen at elevated rates (11-12%) in-line with recent issuances by other NBFCs. The yield on loan portfolio is expected to remain firm during the year despite intensifying competition aided by the recent hike (1-15bps) in interest rate by the company. Share price trend Muthoot May-11 Jun-11 Sensex RoA to marginally come-off; RoE to remain impressive though Significant improvement in AUM/Branch (from Rs58mn to Rs8mn over FY11-13) and lower incremental marketing/promotion expenditure would drive some operating leverage. Resultantly, opex/average assets ratio is estimated to decline by 3bps over FY11-13 to 3.6% marginally cushioning the impact of NIM contraction on RoA. The recent IPO has augmented capital adequacy and reduced leverage. RoE, as a result, is likely to normalize to 3-35% from 51% in FY11. Considering the estimated robust earnings of 39% over FY11-13, we initiate coverage on Muthoot with a BUY rating and 9-month target of Rs22. Financial summary Y/e 31 Mar (Rs m) FY1 FY11 FY12E FY13E Total operating income 6,157 12,832 18,37 25,29 Yoy growth Operating profit (pre-provisions) 3,477 7,936 11,22 15,573 Net profit 2,276 4,942 6,891 9,576 yoy growth EPS (Rs) BVPS (Rs) P/E (x) P/BV (x) ROE ROA CAR June 21, 211

8 Muthoot Finance Ltd Market share in the organized gold loan industry stood at ~2% in FY1 Has witnessed a 82% AUM CAGR over the past four years Gold stock has increased from 23MT to 112MT over FY7-11 Through its ~2,9 branches, company has presence across 21 states and 4 union territories Promoters have an extensive 7 years of experience in the gold loan business Largest gold financing company in the country Muthoot Finance (Muthoot) is the largest gold financing company in India with a gross gold loan portfolio of Rs15.9bn as at March 211. Gold loans comprised about 99% of the company s AUM. As per IMaCS Industry Report 21 Update, Muthoot s market share in the organized gold loan industry stood at ~2%. With company having witnessed a phenomenal 82% CAGR over the past four years, Muthoot s market share has increased significantly from 11% in FY7. The robust business growth has been driven by substantial network expansion (49% CAGR in branches), significant improvement in branch productivity, sustained rally in gold prices and strong brand recognition. Gold stock has increased from 23MT to 112MT over FY7-11 representing 49% CAGR. Muthoot employed 23,688 people at the end of FY11. About 67% of company s branches are located in southern region which contributes 74% to the gross gold loan portfolio. However, the business share of other regions has increased over the past three years with Muthoot s strong emphasis on regional diversification. Presently, through its ~2,9 branches, company has presence across 21 states and 4 union territories. As per the company, it has been serving 65,-7, gold loan customers per day in recent months. Muthoot is a systemically important non-deposit taking NBFC headquartered in the state of Kerala. Muthoot s promoters have an extensive 7 years of experience in the gold loan business and the current management has demonstrated the ability to drive and manage multi-fold business growth. In addition to the gold loans business, company provides money transfer services through its branches (sub-agents of various registered money transfer agencies) and has recently commenced providing collection agency services. Muthoot also operates three windmills in the state of Tamil Nadu. Gross gold loan portfolio has witnessed 82% CAGR over FY7-11 Gross Gold Loans Gold Stock Robust branch expansion has driven AUM growth No of Branches No of Employees (Rs bn) (MT) , 2,5 (no) (no) 18, 15, , 12, ,5 9, 6 5 1, 6, , FY7 FY8 FY9 FY1 FY11 FY7 FY8 FY9 FY1 FY11 Sector Report 8

9 Muthoot Finance Ltd Regional distribution of branches 67% in South 1.% East West North South Regional distribution of gross gold loan portfolio 74% in South 1.% East West North South 8.% 6.% 8.% 6.% 4.% 2.% 4.% 2.%.% FY7 FY8 FY9 FY1 FY11.% FY7 FY8 FY9 FY1 FY11 Company had 4.7mn loan accounts at the end of FY11 Interest rate vary in the range of 12-3% pa; most of the loans are in the range of Rs5,-5, Average tenure of loans is about 4 months As loans are over-collateralized by, credit assessment and documentary requirements are minimal Two key factors that impact response time are loan ticket size and number of items pledged Company has two staff training colleges and three regional training centers Catering to individual customers requiring short-term loans Muthoot s gold loan customers are typically small businessmen, vendors, traders, farmers and salaried individuals, who for reasons of convenience, accessibility or necessity, avail of credit by pledging their gold jewellery. Company had 4.7mn loan accounts at the end of FY11, representing a 68% yoy growth. Muthoot offers loans for varying amounts, interest rates and exposures (LTVs). The principal loan amount usually ranges from Rs2,-1, while the interest rate could vary in the range of 12-3% per annum. As per the company, most of the loans are in the range of Rs5,-5,. Aided by the handsome rally in the gold prices, average ticket size of loans has been increasing materially. It was Rs33,464 in FY11, higher 28% over FY1. Loans are offered for a maximum tenure of 12 months, however, the average tenure is about 4 months. Average LTV (loan-tovalue) is at 72% on the pure weight of gold with 35-4% of the loans having an LTV >7%. Short response time for disbursements Each branch of Muthoot is staffed with persons possessing local knowledge and understanding of customers' needs and who are adequately trained to appraise collateral and disburse loans within a few minutes. Although, Muthoot conducts certain know-your-customer (KYC) procedures at the time of sanctioning a loan, the company generally relies on the quality of the gold jewellery provided as collateral rather than on a stringent credit analysis of the customer. Further, since loans are over-collateralized by gold jewellery, credit assessment and documentary requirements are rather minimal thereby significantly shortening the turnaround time for disbursement. The two key factors that impact response time are loan ticket size and number of items pledged. Company claims to disburse loans up to Rs2, in size within five minutes from the time gold is tendered to appraiser. The ability to timely appraise the quality of the gold jewellery collateral is critical to the response time. However, assessing gold jewellery quickly is a specialized skill as it requires assessing jewellery for gold content and quality manually without damaging the ornaments. Muthoot has two staff training colleges, one each in Cochin and Delhi, and three regional training centers located in Chennai, Hyderabad and Bangalore. The staff training colleges and regional training centers are used to train new employees in appraisal skills, customer relations and communication skills. Sector Report 9

10 Muthoot Finance Ltd Muthoot has significantly outpaced industry growth over FY7-11 Expect AUM growth to moderate significantly; estimate FY11-13 CAGR at 37.5% Substantial growth would be driven by relatively new branches AUM/Branch to increase from Rs58mn at end-fy11 to Rs8mn at end-fy13 AUM growth to moderate significantly over FY11-13E Despite being the largest player in the organized gold loan market, Muthoot has significantly outpaced the industry in terms of growth. Company s gross gold loan book has witnessed 82% CAGR over FY7-11 as against 46% CAGR of the organized market. In the past two years, growth has been much stronger at 118% pa. Sheer size of the opportunity, management aggression, timely fund raising, robust branch expansion and buoyancy in gold prices have driven the robust growth. Gold stock has increased from 23MT to 112MT over FY7-11 representing 49% CAGR. Gold loans being the flagship lending product for Muthoot constitute 99% of its AUM. Going ahead, we expect AUM growth to moderate significantly on account of increasing penetration and competition in South (especially Kerala) and slower adoption of gold loan product in other regions. Further, if the gold rally were to halt, AUM growth would be purely volume driven. We factor in a substantial moderation and expect AUM CAGR of 37.5% over FY With Muthoot having added ~1,75 branches (64% of March-ending strength) in the past two years, we believe that a substantial portion of the incremental growth would be driven by these relatively new branches. Company has planned for a modest branch addition of 5 each in FY12 and FY13. Resultantly, average branch productivity is estimated to shoot up with AUM/Branch increasing by 38% from Rs58mn at end-fy11 to Rs8mn at end-fy13. AUM to witness 37.5% CAGR over FY11-13E AUM yoy grow th 3 (Rs bn) FY12E and FY13E branch addition to be modest 1,2 1, (no) FY8 FY9 FY1 FY11 FY12E FY13E FY7 FY8 FY9 FY1 FY11 FY12E FY13E AUM/Branch to increase significantly 9 (Rs mn) FY8 FY9 FY1 FY11 FY12E FY13E Sector Report 1

11 Muthoot Finance Ltd Assignments have been ~25% of AUM in the past three years Interest rates on assignments were 15-2bps lower than other bank borrowings RBI recently precluded gold loans from being classified as PSL for banks Thus, interest benefit on loan assignments has disappeared Company has assigned loans worth ~Rs8bn since the RBI circular Lower assignments would prop-up net loan CAGR to 57.5% over FY11-13 Assignments to come-off sharply; net loan book to grow much faster than AUM Loan assignment has been a significant feature for Muthoot forming ~25% of its AUM in the past three years. Company has been selling a portion of its loan portfolio to banks on regular basis for an upfront fixed consideration. This arrangement represented a relatively cheaper source of capital as the interest rates were 15-2bps lower than other bank borrowings. The interest benefit was offered by banks as the purchased portfolio could be classified under the agriculture sector for meeting the priority sector lending target. Under such transactions, Muthoot has to provide credit enhancement through fixed deposits with respective bank or by issuing a corporate guarantee for an amount equal to a negotiated percentage of the value of the loans being assigned. The assigned book and liability does not appear on the balance sheet of the company. Cash raised by assignment is used for generating fresh gold loans. The loans assigned are managed by the company (therefore, customers not impacted) and interest income as well as assignment expenses are recorded in the P&L. On maturity of the assigned portfolio, the repayment goes to the bank and assignment liability disappears. In a recent circular (dated February 2 nd 211), RBI precluded gold loans from being classified under the agriculture sector for meeting PSL requirements. Thus the interest benefit has disappeared and the cost of loan assignments has become similar to other bank borrowings. As per the company, the new regulation would apply to new assignments and not impact the existing arrangements. Also, it is unlikely to impact the availability of funds. In the absence of any interest advantage under assignments, company expects majority of its incremental bank borrowings through its routine cash credit/working capital loan facility. With some of the banks still interested, company has assigned loans worth ~Rs8bn since the RBI circular. However, management has hinted at lower assignments going ahead. With this, bulk of the growth would be reflected on the balance sheet thereby propping up the net loan CAGR to 57.5% over FY Assignments to decline sharply on loss of PSL status Assignments as a % of AUM Resultantly, net loan book on balance sheet to grow much faster than AUM Net loan book yoy grow th 48 4 (Rs bn) (Rs bn) FY8 FY9 FY1 FY11 FY12E FY13E FY8 FY9 FY1 FY11 FY12E FY13E Sector Report 11

12 Muthoot Finance Ltd Borrowing mix to materially shift towards retail secured NCDs and bank borrowings Share of equity in Total Assets funding has received a boost from recent IPO n Share of NCDs and Banks to increase in borrowings The primary sources of borrowing for Muthoot have been Retail secured NCDs (known as Muthoot Gold Bonds), banks (CC/WC loan facility) and assignments. Combined, these three sources formed 9% of company s total borrowings. Retail NCDs having a term of 1, 2 or 3 years are placed privately to the customers visiting branches. With assignment estimated to significantly come down, the borrowing mix would move materially shift towards retail secured NCDs and bank borrowings. The share of subordinated debt and other forms of borrowings including CPs would also rise. The share of equity in Total Assets (including Assignments) funding would receive a boost from the recent IPO of ~Rs9bn. Borrowing profile as at FY11-end NCD - MGB Banks Borrow ings Subordinated debt Assignments Others 6% 26% 26% Total asset (incl. assignments) funding mix trend Ow ned Funds NCD - MGB Banks Borrow Subordinated debt Assignments Others 1.% 8.% 6.% 4.% 4% 38% 2.%.% FY7 FY8 FY9 FY1 FY11 FY12E FY13E 3-35% of borrowings carry fixed rate of interest v/s 1% of loans Cost of bank borrowings has shot-up by 15-2bps in the recent past Interest rate offered on Retail NCDs would also track the macro trend Expect Muthoot s funding cost to increase sharply by 18bps in FY12. Cost of borrowing to rise materially in FY12E Muthoot s cost of borrowing stood at 8.8% for FY11 representing a marginal increase over FY1. As against 1% of loans assets that are at fixed rates, only 3-35% of company s borrowings (primarily NCDs and subordinated debt) carry fixed rate of interest. The interest rate on the balance 65% borrowings, mainly from banks (assignment and others), are floating linked to the respective banks' BPLR or base rate. In the recent past, the cost of bank borrowing (including assignments) has shot-up by 15-2bps due to material increase in lending rates and loss of PSL status for assignments. The central bank s monetary tightening and difficult liquidity conditions have forced all commercial banks to raise their BPLR and base rate substantially over the past 6-9 months. The interest rate offered on Retail NCDs would also track the macro trend as already seen in higher rates (11-12%) being offered by many NBFCs on new NCD issuances. We therefore expect Muthoot s cost of borrowings to witness a steep increase of 18bps in FY12. Sector Report 12

13 Muthoot Finance Ltd Cost of funds to rise by 18bps in FY12E FY8 FY9 FY1 FY11 FY12E FY13E Yield on loan portfolio has been steady around 2% over the past five years Recently, company has raised interest rates on loans by 1-15bps to passon the increase in funding cost Expect a stable loan yield in FY12 and a correction of 7bps in FY13 NIM to decline sharply by 14bps in FY12 due to steep increase in funding cost Yield to be resilient in FY12E but may weaken in FY13E; NIM to correct materially The average yield earned on the loan portfolio was 19.7% in FY11. It has been steady around 2% over the past five years despite a significant increase in organized competition. As per Muthoot, further competition in the Southern region is also unlikely to impact its loan yields as the overall business pie is expanding with increasing adoption of gold loans by middle and higher income individuals. Recently, company has raised interest rates on loans by 1-15bps to pass-on the increase in funding cost thus reflecting its strong pricing power. Company s loan yield is materially lower when compared to its closest competitor, Manappuram, and in-line with most NBFCs present in the gold loan segment. We assume a stable loan yield in FY12 and a correction of 7bps in FY13 factoring some impact of intensifying competition. NIM on the other hand is estimated to decline sharply by 14bps in FY12 due to steep increase in funding cost. This would be despite the beneficial impact of the recent equity raising though an IPO. NIM is likely to stabilize in FY13 near 9.5%. The key upside risk to our margin assumption for FY13 would be a sharp reversal in interest rate cycle. Yield on AUM to be relatively stable NIM to witness steep fall in FY12E due to sharp increase in funding cost FY7 FY8 FY9 FY1 FY11 FY12E FY13E 6. FY7 FY8 FY9 FY1 FY11 FY12E FY13E Sector Report 13

14 Muthoot Finance Ltd AUM/Branch to increase sharply from Rs58mn in FY11 to Rs8mn in FY13 Operating leverage would be driven by advertising and other opex Opex/average assets ratio to decline from 3.9% in FY11 to 3.6% in FY13 Improvement in branch productivity would drive some operating leverage With substantial growth to be driven by relatively younger branches (<2 years old) and modest new branch addition plans, we expect average branch productivity to witness a significant jump. Year-ending AUM/Branch is estimated to increase sharply from Rs58mn in FY11 to Rs8mn in FY13. This is likely to kick-in some operating leverage for Muthoot over the next two years. We don t expect any leverage in staff and rent expenditure as salary and rental inflation would likely remain firm. Material leverage would actually come in from advertising and other opex. The advertising expenditure has increased three-fold in the past two years driven by aggressive marketing and promotion to improve brand awareness. Company expects only a marginal increase in FY12. Lower other opex ratio would be driven by higher capacity utilization. Overall, we expect opex/average assets ratio to decline from 3.9% in FY11 to 3.6% in FY13. Advertising and other opex would be the drivers of operating leverage Staff Exp Rent Advertising Other Opex (% of Avg Assets) Opex/Avg. Assets to decline marginally over FY11-13E FY8 FY9 FY1 FY11 FY12E FY13E 2.5 FY8 FY9 FY1 FY11 FY12E FY13E Company raised ~Rs9bn through an IPO in April 211 augmenting its Tier-1 ratio by ~7bps Tier-1 ratio is unlikely to dip below 1% over the next two years aided by substantial plough backs Recent equity issuance has augmented capital adequacy; further dilution unlikely till FY13E As per the revised norms of RBI, all systemically important nondeposit taking NBFCs are required to maintain a CAR of at least 15% from March 31, 211. To adhere to this regulation in the backdrop of strong business growth, Muthoot raised ~Rs9bn (67% of its FY11 networth) through an IPO in the month of April 211. This has significantly augmented its Tier-1 ratio (likely by ~7bps) which stood at 1.3% at the end of FY11, just above new minimum requirement of 1%. Though AUM growth is expected to moderate substantially over the next two years, capital consumption would remain high as bulk of the growth would be reflected on balance sheet. However, the Tier-1 ratio is unlikely to dip below 1% over the next two years aided by substantial plough backs. We therefore do not foresee any need for further equity dilution in the medium term. Sector Report 14

15 Muthoot Finance Ltd Capital adequacy augmented by recent IPO; Tier-1 ratio to remain comfortable CAR Tier-1 Plough backs would be substantial in FY12E and FY13E; would aid capital adequacy (Rs bn) 5. FY7 FY8 FY9 FY1 FY11 FY12E FY13E FY7 FY8 FY9 FY1 FY11 FY12E FY13E Muthoot s GNPL% has moved in a narrow band of.2-.5% in the past five years Historically, company s NPL provisioning has been limited to regulatory levels Expect more conservative provisioning by the company in future Negligible asset quality concerns With gold loans constituting 99% of AUM, Muthoot s GNPL% has moved in a narrow band of.2-.5% in the past five years. As the pledged gold jewelry holds high sentimental value for the borrower, defaults have been rare. In the case of a default, company sells the gold jewellery collateral through auctions to the local jewellers. The loans are over-collateralized thereby providing cushion against material correction in gold prices. Therefore, probability of any loss arising to the company is extremely low. Historically, Muthoot provisioning for NPLs has been limited to regulatory requirements 1% for sub-standard assets and 5-1% for doubtful assets. With 95% of NPLs being sub-standard assets, overall provisioning cover stands lower at 15%. We expect more conservative provisioning by the company in future taking the provisioning cover to 25% by FY13. During Q3 FY11, RBI introduced.25% provisioning for standard gold loans which the company met in H2 FY11. We estimate stable credit charge in FY12 and FY13 at.3%. Asset quality to remain robust Credit charge to be stabilize near.3%.6.5 GNPL NNPL FY7 FY8 FY9 FY1 FY11 FY12E FY13E. FY8 FY9 FY1 FY11 FY12E FY13E Sector Report 15

16 Muthoot Finance Ltd RoA to decline by marginal 3bps over FY11-13 to 3.6% RoE to normalize to 3-35% with recent reduction in leverage RoA to come-off marginally; RoE to decline but remain robust Muthoot s RoA in FY11 was handsome 3.9% reflecting its robust profitability. In the next two years, a key headwind for RoA would be the anticipated 14bps decline in NIM. However, this would be partly offset by the expected operating leverage. With asset quality to remain sanguine, provisioning in unlikely to pose any threat to profitability. Overall, we estimate Muthoot s RoA to decline by marginal 3bps over FY11-13 to 3.6%. RoE, which stood at exceptional 51.9% in FY11 due to peak leverage (9x), would normalize to above 3% with leverage correcting to around 7x. Decline in PAT/AUM % to be lower than NIM cushioned by operating leverage RoA to marginally trend down impacted by NIM correction FY8 FY9 FY1 FY11 FY12E FY13E 1.5 FY8 FY9 FY1 FY11 FY12E FY13E RoE to fall from exceptionally high levels due to reduction in leverage RoE Leverage (x) FY8 FY9 FY1 FY11 FY12E FY13E 5. Sector Report 16

17 Muthoot Finance Ltd Overall profitability of Muthoot to remain robust Estimate earnings CAGR at strong 39% over FY11-13 Recommend BUY with a 9-month target of Rs22 Valuation attractive considering robust profitability and strong earnings growth Despite the anticipated slowdown in AUM growth and contraction in margin, overall profitability of Muthoot would still remain robust with RoA in the range of 3.5-4% and RoE in the range of 3-35%. Further, earnings CAGR over FY11-13 is estimated to be strong at 39% on an average AUM growth of 5%. At the current price of Rs154, the stock trades at 12% below the IPO price and at attractive valuation of 1.6x FY13E P/BV. Though there are valid concerns with respect to further increase in the funding cost and potential adverse regulations, current valuation seems to have digested a significant part of it. We initiate coverage on Muthoot with a BUY rating and 9-month target of Rs22 (valued at 2.1x FY13 P/BV). Sector Report 17

18 Muthoot Finance Ltd Financials Income statement Y/e 31 Mar (Rs m) FY1 FY11E FY12E FY13E Interest income 1,775 22,983 37,175 49,134 Interest expense (4,737) (1,326) (19,94) (24,38) Net int income 6,37 12,657 18,82 24,754 Non-int income Total op income 6,157 12,832 18,37 25,29 Total op expenses (2,68) (4,897) (7,87) (9,456) Op prof (pre-prov) 3,477 7,936 11,22 15,573 Provisions (21) (323) (619) (841) Profit before tax 3,456 7,612 1,61 14,732 Taxes (1,18) (2,67) (3,71) (5,156) Net profit 2,276 4,942 6,891 9,576 Balance sheet Y/e 31 Mar (Rs m) FY1 FY11E FY12E FY13E Fixed assets 1,533 2,341 2,435 2,751 Intangible assets Investments Net loans 54, , , ,914 Net Current Assets 2,766 13,516 2,132 1,883 Def Tax Asset (Net) (21) (23) (23) (23) Total assets 58,65 132,73 216, ,61 Net worth 5,845 13,344 27,942 35,778 Secured loans 45,471 12, , ,633 Unsecured loans 7,334 17,274 26,91 36,189 Total liabilities 52,85 119, , ,822 Equity + Total liabilities 58, ,73 216, ,61 Key ratios Y/e 31 Mar FY1 FY11E FY12E FY13E Growth matrix Net interest income Total op income Op profit (preprovision) Net profit Loans Borrowings Total assets Profitability Ratios NIM Return on Avg Equity Return on Avg Assets Per share ratios (Rs) EPS BVPS DPS Other key ratios Loans/Borrowings Opex /Avg. Assets CAR Tier-I capital Gross NPLs/Loans Total prov/avg loans Net NPLs/Net loans Tax rate Dividend yield Sector Report 18

19 Manappuram Finance & Leasing BUY Comfortably placed Sector: Financials Sensex: 17,57 CMP (Rs): 57 Target price (Rs): 73 Upside : Week h/l (Rs): 95/35 Market cap (Rscr) : 4,744 6m Avg vol ( Nos): 2,742 No of o/s shares (mn): 834 FV (Rs): 2 Bloomberg code: MGFL IN Reuters code: MGFL.BO BSE code: NSE code: MANAPPURAM Prices as on 2 Jun, 211 Shareholding pattern March'11 Promoters 36.5 Institutions 31.9 Non promoter corp hold.9 Public & others 3.7 Performance rel. to sensex 1m 3m 1yr Manappuram 4.3 (2.5) 53.5 Muthoot M&M Fin (1.9) (1.7) 36.1 Shriram Tran (6.9) (15.6) 2.1 Share price trend Manappuram Sensex Jun-1 Dec-1 Jun-11 Fastest growing gold loan company; 8x AUM growth over FY9-11 Manappuram has been the fastest growing gold loan company in the country. It has tripled its AUM in the past one year and grown it eight times in the last two years. Company is the second largest listed gold loan company after Muthoot with ~7% share of the organized market. Apart from a sustained rally in gold prices, substantial network expansion (79% CAGR in branches over FY9-11) has driven the exponential growth in AUM. The robust growth was mainly funded by two back-to-back QIP issues in FY1 (Rs2.45bn) and FY11 (Rs1bn). Presently, >75% of its 2,2-2,3 branches are located in the largest business region of South that contributes a disproportionate ~87% to company s business. New branches to drive 45% AUM CAGR over FY11-13E After a significant outperformance to industry growth, we expect Manappuram s growth momentum to moderate over FY11-13 to 45% with increased penetration/competition in South (especially Kerala) and slower adoption in other regions. More importantly, net loans (on the balance sheet) would witness a higher 57% CAGR in the absence of any loan assignments in future. With Manappuram having more than doubled its branches in FY11, bulk of the anticipated growth would be fuelled by substantial uptick in productivity of the new branches. NIM to contract on declining yield and increase in funding cost We estimate Manappuram s margin to correct by ~36bps over FY11-13 from 16.7% to 13.1%. Current loan yield at ~24% is not only substantially higher than interest charged by commercial and cooperative banks but also materially elevated than Muthoot, a like-to-like competitor. Increasing competition in Southern region could push company s yield lower in the medium term. On the other hand, funding cost has already increased by 15-2 bps qoq in Q1 FY12 due to loss of PSL status on assignments and increase in bank lending/cp rates. Operating leverage to cushion RoA while RoE to improve With company having significantly invested in capacity augmentation and brand awareness, material operating leverage would kick-in over FY We expect a substantial improvement in AUM/Branch from Rs36mn to Rs55mn as new branches mature. Further, advertising expenditure is estimated to remain stable or marginally increase. As such, opex/average assets ratio is likely to decline considerably from 7% in FY11 to 5.5% in FY13. This would cushion the impact of margin contraction on RoA. However, RoE would improve as leverage increases from 2.9x to 5.1x. Given the strong growth and profitability profile, we initiate coverage on Manappuram with a BUY rating and 9-month target of Rs73. Financial summary Y/e 31 Mar (Rs m) FY1 FY11 FY12E FY13E Total operating income 3,413 8,496 13,325 17,755 Yoy growth Operating profit (pre-provisions) 1,97 4,373 7,168 9,687 Net profit 1,197 2,827 4,498 6,16 yoy growth EPS (Rs) BVPS (Rs) P/E (x) P/BV (x) ROE ROA CAR June 21, 211

20 Manappuram General Finance & Leasing Ltd Manappuram is the second largest listed gold loan company with ~7% share of the organized market By having grown its AUM 8xin the past two years, Manappuram is the fastest growing gold loan company Exponential growth was supported by substantial branch addition and the rally in gold prices >75% of branches are located in the largest business region of South In terms of business, Southern region has a disproportionate share of ~87% Strong Board comprising 13 members with high level of independence Fastest growing gold loan company Headquartered in the State of Kerala, Manappuram General Finance and Leasing Ltd (Manappuram) is the second largest listed gold loan company with ~7% share of the organized market. Initially registered as deposit taking NBFC, company has changed its status recently to become a non-deposit taking NBFC. Manappuram, a flagship company of Manappuram Group, is primarily engaged in providing loans against household used jewellery pledged by customers. As at March 211, company s AUM stood at Rs75bn; 99.3% of which were gold loans and remaining are historical portfolio of hypothecation against vehicle loans and other business/personal loans. By having tripled its AUM is the past one year and grown eight times in the past two years, Manappuram is the fastest growing gold loan company in the country. The exponential growth was supported by substantial branch (79% CAGR over FY9-11) and employee (13% CAGR over FY9-11) addition. A sustained rally in gold prices also played a critical role in AUM accretion. The robust growth was funded mainly by two back-toback QIP issues in FY1 (Rs2.45bn) and FY11 (Rs1bn). Presently, more than 75% of its 2,2-2,3 branches are located in the largest business region of South (uniformly spread across Kerala, Tamil Nadu, Karnataka and Andhra Pradesh). In terms of business, Southern region has a disproportionate share of ~87%. However, this has been declining gradually as company has been aggressively adding branches in the other three regions. Manappuram employed 16,751 employees as at end-march 211. Manappuram was founded by late V C Padmanabhan in 1949 and is currently managed by his son V P Nandakumar, who is the Executive Chairman. Company has a strong Board comprising 13 members with high level of independence. AUM has grown 8x in the past two years 9 (Rs bn) Branch expansion has supported AUM growth 2,4 (no) 2, 1,6 1,2 8 4 FY7 FY8 FY9 FY1 FY11 FY8 FY9 FY1 FY11 Sector Report 2