Manappuram Finance. Institutional Equities. 2QFY19 Result Update BUY

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1 2QFY19 Result Update Manappuram Finance 9 November 2018 Reuters: MNFL.BO; Bloomberg: MGFL IN Positive All-round Results Should Set The Tone Manappuram Finance (MFL) reported its 2QFY19 results with the key pointers being: (1) Gold loan AUM growth at 1% QoQ was softer than past 3-quarter average of 5% but was impacted by physical gold price deflation (2) MFI subsidiary Asirvad augmented consolidated RoE for the second quarter running by delivering an RoE of 28% for 2QFY19 (3) Non-gold non-mfi businesses continued to see good traction underlining embedded operating leverage. Share of non-gold loans in total AUM rose 170 bps QoQ to 26.7% (4) Security costs, an opex worry some quarters ago, has been reined in via technology initiatives. (See comprehensive conference call takeaways below; see initiating coverage report here). Per se, on the results front, MFL posted NII growth of 19% YoY and 9% QoQ at Rs6,738mn, PPOP growth of 28% YoY and 13% QoQ at Rs3,662mn and PAT growth of 39% YoY and 12% QoQ at Rs2,222mn. We have revised our estimates for FY19/FY20/FY21 and retained Buy rating on MFL, revising our target price to Rs112 (from Rs103 earlier), valuing the stock at 1.6x 1HFY21E P/BV. Gold loan AUM growth at 1% QoQ was softer than past 3-quarter average of 5% but was impacted by physical gold price deflation: Gold loan AUM growth lagged gold holdings growth of 2.1% QoQ due to gold price deflation during the quarter. We do not think Gold price deflation is a sustainable theme since (1) we believe the froth had exited the global gold prices once the long-term global gold bear market ended in 2016 and such bear markets for gold are once-in-a-generation themes (2) Indian gold prices are protected by an INR depreciation overlay, which is a long-term structural expectation. Indeed, Indian gold prices have bounced back and have recently traded at 6-year highs. Importantly, structural revival in gold lending has been underway since 2QFY18-end with gold AUM growth of 17% YoY in 2QFY19, which is a fairly attractive growth rate for loans against gold, given it is a business of high sustainable margin and low credit costs and, thus of high steady state RoA. Management had earlier stated LGD for the business is just 63 bps. The business has great recourse to passing on rising cost of funds to customers and this was witnessed in the 80 bps QoQ rise in net yield for MFL due to the discontinuance interest waivers on online gold loans. Liquidity issues arising out ALM mismatch are a non-issue for gold lending and more so MFL because of the vast majority of its gold loans tenure being capped at 3 months. Average effective tenure for MFL gold loans is ~2 months. MFI subsidiary Asirvad augmented consolidated RoE for the second quarter running by delivering an RoE of 28% for 2QFY19: Asirvad Microfinance saw its portfolio grow 12% QoQ and its geographical diversification journey continued apace. Non-south regions contributed 54% to AUM compared with 42% 12 months ago. Tamil Nadu alone contributed ~80% to AUM at the time of being acquired by MFL but this has declined to below 30% currently. Asirvad has no exposure to commercial paper and has not faced any funding issues. In any case, the nature of Asirvad s lending is also short-term in nature leading to positive ALM gap. Non-gold non-mfi businesses continued to see good traction underlining embedded operating leverage. Share of non-gold loans in total AUM rose 170 bps QoQ to 26.7%: Vehicle finance, in particular, continued its stellar performance, growing 95% YoY. It remains a business of outsized embedded operating leverage as it is carried out from existing gold loan branches, which are 3330 in number. The housing finance business, which was in a state of flux a few quarters ago, seems to have stabilized with pace of NPA accretion slowing down. GNPA ratio for the business inched up ~10 bps QoQ to 4.7%. Management stated that they are hopeful of a positive revert from RBI on the ISFC acquisition front in a month or so since they have made a representation to the regulator in this regard. Valuation and outlook: We have retained our NII estimates, revised our PPOP estimates by -1.5%/0.8%/0.3% and PAT estimates by -2.4%/1.5%/0.2% for FY19/FY20/FY21, respectively. We have retained Buy rating on MFL, valuing the stock at 1.6x 1HFY21E P/BV and revising our target price to Rs112 (from Rs103 earlier). BUY Sector: NBFC CMP: Rs83 Target Price: Rs112 Upside: 36% Shivaji Thapliyal Research Analyst shivaji.thapliyal@nirmalbang.com Key Data Current Shares O/S (mn) Mkt Cap (Rsbn/US$bn) 95.1/ Wk H / L (Rs) 130/82 Daily Vol. (3M NSE Avg.) 3,826,635 Price Performance (%) 1 M 6 M 1 Yr Manappuram Finance Nifty Index Source: Bloomberg Y/E March (Rsmn) 2QFY19 2QFY18 1QFY19 YoY (%) QoQ (%) Interest income 9,911 8,109 9, Interest expenses 3,173 2,448 2, Net interest income 6,738 5,661 6, Calculated NIM (%) (53bps) 76 bps Fee & other income Operating income 7,102 5,954 6, Staff costs 1,773 1,557 1, Other operating expenses 1,668 1,533 1, Total operating expenses 3,440 3,090 3, Cost to-income (%) (345bps) (180bps) Cost-to-AUM (%) (100bps) (10bps) Operating profit 3,662 2,864 3, Provisions (64.2) 4.9 Credit costs (%) (95bps) - PBT 3,499 2,411 3, Tax/ Minority Interest 1, , Effective tax rate bps 58 bps Adjusted PAT 2,222 1,598 1, Other comprehensive income (8) (16) 6 NA NA Total Comprehensive Income 2,214 1,582 1, EPS (Rs) AUM (Rsmn) 171, , , Source: Company, Nirmal Bang Research

2 Comprehensive Conference Call Takeaways Asset Quality The management stated that the impact of Kerala floods was only seen in delay in collections. They didn t witness any credit loss due to the same. The management stated that the auctions amounted to Rs1,040mn during the quarter. Manappuram Finance has been making provisions in excess of IndAS norms. The management stated that they continue to provide on gold loans as per RBI norms, which exceed IndAS norms. The management stated that they have not taken any RBI dispensation for provisioning arising from Kerala floods. Exposure to Kerala stands at ~6% of the consolidated AUM. In Kerala, MFI book stands at Rs2,000mn, vehicle finance book at Rs300mn and HFC book at Rs200mn. The management stated that they are not expecting any credit loss from any business due to Kerala floods. The management stated that only the small and medium sized MFIs of AUM less than Rs10bn have seen problems. In the last 30 days microfinance lending rate has been hiked by 25bps in line with rise in borrowing cost. The management stated that the NBFC book stood at Rs5,600mn. 20% of this amount was to MFIs, in which regular collections are being made. Rest of the NBFC book comprises CV lenders and MSME lenders. The management stated that after systemic issues such as demonetization, awareness regarding the cost of spoiling one s credit history by default is rising. The management categorically stated that the MFI loans are not included in farm loan waivers. Loan and Business Growth The management stated that the overall growth was reasonable despite the monsoon season turning out to be somewhat below par. The management stated that the lower gold prices impacted QoQ gold loan AUM growth. They have provided a 10-12% gold loan growth guidance for FY19. The management is targeting the non-gold loan book to contribute 50% of the total loan book by the next 10 years. The management stated that a total of Rs3,370mn worth of disbursements were made during the quarter. The management stated that the breakeven level is Rs15mn AUM per branch. Margin, Liabilities and Liquidity Marginal cost of borrowing rate rose 11bps QoQ to 8.88%. The management explained that ~90% of consolidated AUM (gold loans + microfinance) is short-term in nature and therefore ALM problems do not exist for MFL. The management stated that the weighted average LTV on gold loans was 66%. The management stated that the schemes which provided aggressive discounts were discontinued and they will not be brought back. This was a timely action in an increasing borrowing cost environment. The management stated that more than 50% of the NCD borrowings came from institutions which are generally of medium to long term tenure and about 10% came from retail NCDs. 2 Manappuram Finance

3 The management stated that the average actual tenure of the gold loans stood at around 60 days. Overall, the NBFC has a high capital adequacy and good credit rating. All CPs have been renewed and so have all bank contracts. The average tenure of CPs is days. The management guided that the current liability mix will continue and stressed on the point that the lenders have an understanding of Manappuram Finance s positive ALM position. Operating Expenses Employee count stood at 25,104 as of this quarter end. On the technology front, the management stated that they develop their own technology as well as through outsourcing. On the gold loan book, they use their in-house technology. For the vehicle loan book, they outsource it. They also use some of the analytics platforms. The whole NBFC s IT infrastructure is handled by IBM. The total technology cost amounts to Rs400mn. The management stated that their branch network is new compared to their key competitors, which explains their lower AUM per branch. They are planning to add 100 branches a year going forward. The management stated that the security costs are coming down Rs50mn per quarter due to technology initiatives. It will stabilize at Rs750mn levels, which earlier was at ~Rs1,400mn. Subsidiaries and Cross-Sell On the investment made in ISFC, the management stated that initially RBI did not give approval, but they have made a representation to RBI. The management believes the outcome will be positive and one should hear from RBI in a month. Borrowing mix of Asirvad Microfinance is as follows: bank borrowings 30%, NBFC borrowing 16%, securitization 10% and the rest is NCDs. There is no exposure to commercial borrowing. In Asirvad Microfinance, to begin with, 80% of the total portfolio originated in Tamil Nadu. Now, the total portfolio has spread across 21 states and more states are in the pipeline to be added. Tamil Nadu exposure has reduced to less than 30% and the management is targeting an year-end figure of 25%. Each of the other states has a share of less than 10%. The management stated that they have an insurance broking subsidiary which has an income of over Rs100mn now. With more branches, customers and products, the management believes the firm will scale up on the cross-sell front. On Asirvad Finance, the management stated that they will build Rs4-5bn of micro enterprise portfolio in the next months. The management has indicated that they would like to list Asirvad Microfinance but have not picked any timeline as such. On their gold and MFI loan book, total customers stood at 4.5mn. The management stated that given their expanding customer base they will explore all opportunities of cross-selling. Some of the crossselling loan offerings are 2-wheelers, affordable housing. They are also planning to start micro enterprise lending. 3 Manappuram Finance

4 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18 Nov-18 Exhibit 1: Financial summary Y/E March (Rsmn) FY17 FY18 FY19E FY20E FY21E Net interest income 22,075 23,815 25,786 28,745 34,464 Pre-provision profit 12,749 14,063 14,940 16,745 21,780 PAT 7,584 6,684 8,664 9,809 12,803 EPS (Rs) BV (Rs) P/E (x) P/BV (x) Gross NPAs (%) Net NPAs (%) RoA (%) RoE (%) Source: Company, Nirmal Bang Research Exhibit 2: Actual performance versus our estimates (Rsmn) 2QFY19 2QFY18 1QFY19 YoY (%) QoQ (%) 2QFY19E Devi. (%) Net interest income 6,738 5,661 6, , Pre-provision profit 3,662 2,864 3, , PAT 2,222 1,598 1, , Source: Company, Nirmal Bang Research Exhibit 3: Change in our estimates Revised estimate Earlier estimate % Revision FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E Net interest income (Rsmn) 25,786 28,745 34,464 25,786 28,745 34, NIM (%) Operating profit (Rsmn) 14,940 16,745 21,780 15,171 16,617 21,720 (1.5) Profit after tax (Rsmn) 8,664 9,809 12,803 8,876 9,665 12,782 (2.4) Source: Company, Nirmal Bang Research Exhibit 4: One-year forward P/BV (x) P/BVPS Mean +1 SD -1 SD +2 SD -2 SD Source: Company, Nirmal Bang Research 4 Manappuram Finance

5 Financials Exhibit 5: Income statement Y/E March (Rsmn) FY17 FY18 FY19E FY20E FY21E Interest income 33,762 34,092 38,949 44,263 53,436 Interest expenses 11,687 10,277 13,163 15,519 18,973 Net interest income 22,075 23,815 25,786 28,745 34,464 Non-interest income ,257 Net revenues 22,401 24,489 26,536 29,655 35,720 Operating expenses 9,652 10,426 11,596 12,911 13,940 -Employee expenses 5,026 6,167 6,698 7,523 8,014 -Other expenses 4,626 4,259 4,898 5,388 5,927 Operating profit 12,749 14,063 14,940 16,745 21,780 Provisions 1,093 3,893 1,610 1,654 2,084 PBT 11,656 10,170 13,330 15,091 19,696 Tax 4,072 3,486 4,665 5,282 6,894 PAT 7,584 6,684 8,664 9,809 12,803 Source: Company, Nirmal Bang Research Exhibit 7: Balance sheet Y/E March (Rsmn) FY17 FY18 FY19E FY20E FY21E Share capital 1,684 1,685 1,685 1,685 1,685 Reserves & surplus 31,934 36,677 43,268 50,964 61,594 Net worth 33,618 38,362 44,954 52,649 63,279 Borrowings 109, , , , ,063 Other liability & provisions 8,042 8,000 9,273 11,387 12,715 Total liabilities 151, , , , ,597 Fixed assets 1,869 2,746 3,158 3,631 4,176 Investments Loans 138, , , , ,288 Cash 5,227 6,986 7,496 8,650 10,613 Other assets 5,958 5,907 7,567 8,860 10,469 Total assets 151, , , , ,597 Source: Company, Nirmal Bang Research Exhibit 6: Key ratios Y/E March (Rsmn) FY17 FY18 FY19E FY20E FY21E Growth (%) Net interest income Operating profit Profit after tax (11.9) Business (%) Advances growth Spread (%) Yield on loans Cost of borrowings Spread NIM Operational efficiency (%) Cost-to- income Cost- to-assets Productivity (Rsmn) AUM per branch AUM per employee Employee per branch CRAR (%) Tier I Tier II Total Asset quality (%) Gross NPAs Net NPAs Specific provision coverage Credit costs (excluding std. assets) Credit costs (including std. assets) Return ratios (%) RoE RoA Per share (%) EPS BV ABV Valuation (x) P/E P/BV P/ABV Source: Company, Nirmal Bang Research 5 Manappuram Finance

6 Apr-17 May-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Rating track Date Rating Market price (Rs) Target price (Rs) 26 March 2018 Buy February 2018 Buy August 2018 Buy October 2018 Buy November 2018 Buy Rating track graph Not Covered Covered 6 Manappuram Finance

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