MUTHOOT FINANCE Asset quality on watch

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1 RESULT UPDATE MUTHOOT FINANCE Asset quality on watch India Equity Research Banking and Financial Services Muthoot Finance s (MUTH) Q1FY14 PAT at INR1.94bn was lower than our estimate on back of ~200bps compression in yields. Management attributed yield decline to cut in lending rates and relatively lower recovery in auction (though no principal loss). While the Street was vigilant on asset quality metrics, the company held on well with stable GNPLs and merely INR60mn write offs. Despite sharp fall in gold prices, AUMs came off 2% QoQ to INR258bn as volume of pledge increased 2% QoQ. Conservatively building flat AUM growth, pressure on NIMs (due to RBI s restriction on raising NCDs via private route) and building higher credit cost, we cut our earnings estimate 15-20% for FY While we are revising our target multiple from 1.5x to 0.9x considering regulatory headwinds, asset quality risk and weakening RoA/RoE, the stock is trading much below at 0.65x. Maintain BUY with TP of INR118. This report also contains Q1FY14/Q4FY13 concall highlights. Yields compress due to cut in lending rates MUTH s lending yields compressed by ~200bps to 19.7% due to: (i) cut in lending rates over past couple of quarters; and (ii) lower realisation from auction with decline in gold prices (though no principal loss). Cost of funds improved a tad from 12.5% in Q4FY13 to 12.2% in Q1FY14. RBI s recent measures which have shot up system-wide interest rates and the central bank s restriction on raising NCDs via the private route (on which MUTH has relatively higher reliance), will create some pressure on funding cost. However, the impact will be limited as borrowing requirement will be minimal with asset growth expected to be muted. The company has INR97bn of unlisted gold bonds with five-year tenor which will have to be replaced with listed NCDs and bank borrowings. We are anticipating NIMs of % over FY14-15E. Outlook and valuations: Vigilant on asset quality; maintain BUY Recent sharp correction in gold prices makes us vigilant on MUTH s asset quality and growth. Moreover, the company s borrowing profile will need transition in favour of bank borrowings and listed NCDs due to RBI s restrictions. While the gold loan industry is going through tough times, we believe MUTH will be able to transition well through this phase given its superior operations and strengthened collection. Assigning a target multiple of 0.9x FY15E book, we maintain BUY/SP. Financials (INR mn) Year to March Q1FY14 Q1FY13 Growth (%) Q2FY11 Growth (%) FY13 FY14E FY15E Net oper. Inc. 5,543 5,939 (6.7) 6,640 (16.5) 25,447 22,210 23,795 PAT 1,939 2,461 (21.2) 2,202 (11.9) 10,042 7,394 7,692 BV per share (INR) Diluted EPS (INR) Price/ Book (x) Diluted P/E (x) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector BUY Edelweiss Securities Limited Performer Risk Rating Relative to Sector Medium Sector Relative to Market Equalweight MARKET DATA (R: MUTT.BO, B: MUTH IN) CMP : INR 87 Target Price : INR week range (INR) : 246 / 86 Share in issue (mn) : M cap (INR bn/usd mn) : 32/ 576 Avg. Daily Vol.BSE/NSE( 000) : SHARE HOLDING PATTERN (%) Current Q4FY13 Q3FY13 Promoters * MF's, FI's & BK s FII's Others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Banks and Financial Services Index 1 month (8.4) months months Kunal Shah kunal.shah@edelweissfin.com Nilesh Parikh nilesh.parikh@edelweissfin.com Prakhar Agarwal prakhar.agarwal@edelweissfin.com July 26, 2013

2 Banking and Financial Services No significant run down in AUMs While we were sceptical on growth and asset quality considering sharp decline in gold prices, MUTH delivered above expectation on both the metrics. AUM growth was marginally down by 2% QoQ to INR258bn as average loan to value (LTV) per gram came off from INR1,940 to INR1,857. However, increased volume (vindicated by 2% QoQ increase in tonnage pledged to 137 tonnes) capped decline in AUM growth. We are building in low single digit growth in AUMs over FY13-15E. Asset quality held on well, though we remain vigilant Asset quality metrics held on well with GNPLs remaining stable at INR5.4bn (though up in percentage terms due to AUM decline). Moreover, bad debts written off were limited to INR60mn despite sharp correction in gold prices. As the portfolio has not seasoned out in its entirety, we remain vigilant on asset quality. Despite provisioning of INR85mn in Q1FY14, we are being cautious on adverse impact of correction in gold prices on asset quality and are building in relatively higher credit cost of INR903mn for FY14. Branch expansion to maintain pace Another 81 branches were added in Q1FY14 (404 branches in FY13), taking the total tally to 4,163. Management guided for addition of branches in FY14 (7-8% increase). In our estimates, we are building in low single digit AUM growth over FY13-15E as improved productivity from branches added in past months will be offset by lower LTV/gram. Other highlights To meet the minimal non-promoter holding requirement of 25% by May 2014, it will go in for fresh issue of equity shares and has passed an enabling resolution to that extent. Chart 1: Challenging environment keeps AUM growth under check (AUM in INR bn) Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Muthoot Finance Chart 2: Given that 33% of existing branches were added in past two years, a ramp up will further support AUMs FY13 FY10 3 Yr and above 39% Less than 1 Yr 10% 1-2 Yr 23% 3 Yr and above 34% Less than 1 Yr 39% 2-3 Yr 28% 2-3 Yr 10% 1-2 Yr 17% Chart 3: Added 81 branches in Q1FY14 5,000 4,000 (No. of branches) 3,000 2,000 1,000 0 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Chart 4: Rationalised employee strength by going slow on fresh recruitments 30 No. of employees (in '000) Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Source: Company 3 Edelweiss Securities Limited

4 Banking and Financial Services Chart 5: Drop in yields pulled down NIMs Q211 Q311 Q411 Q112 (%) (%) Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Yields Cost of funds NIMs Chart 6: Higher reliance more on NCD, assignment portfolio runs down in entirety 100% 80% 60% 40% 20% 0% Q312 Q412 Q113 Q213 Q313 Q413 Q114 Secured NCDs Bank borrowings CP Bilateral assignment Chart 7: Asset quality held on after four consecutive quarters of stress (%) Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Gross NPA Net NPA Source: Company 4 Edelweiss Securities Limited

5 Muthoot Finance Financial snapshot (INR mn) Year to March Q1FY14 Q1FY13 % change Q4FY13 % change FY13 FY14E FY15E Operating income 12,839 12,903 (0.5) 14,064 (8.7) 53,641 50,874 52,944 Interest expanded 7,296 6, ,424 (1.7) 28,194 28,664 29,149 Net operating income 5,543 5,939 (6.7) 6,640 (16.5) 25,447 22,210 23,795 Other income (46.7) 52 (64.1) Total income 5,562 5,974 (6.9) 6,692 (16.9) 25,677 22,460 24,060 Operating expenses 2,497 2, ,714 (8.0) 9,215 9,959 10,897 Pre-provision profit 3,065 3,964 (22.7) 3,978 (22.9) 16,462 12,502 13,163 Provisions & write-offs (88.6) 389 (93.6) ,136 Operating profit 3,040 3,744 (18.8) 3,589 (15.3) 15,566 11,599 12,026 Depreciation (10.9) Profit before tax 2,934 3,642 (19.4) 3,470 (15.4) 15,114 11,119 11,566 Tax 995 1,181 (15.7) 1,268 (21.5) 5,073 3,725 3,875 PAT 1,939 2,461 (21.2) 2,202 (11.9) 10,042 7,394 7,692 Diluted EPS (INR) (21.1) 5.9 (11.8) Other information Branches (No.) 4,163 3,780 4,082 4,082 4,382 4,682 Employees (No.) 24,945 25,103 24,881 24,881 24,977 25,283 AUM 258, , , , , ,234 Ratios Gross NPA - Gold loan (%) 5, , , , , ,016.4 Net NPA - Gold loan (%) 4, , , , , ,013.1 Tax rate (%) Change in estimates FY14E FY15E New Old % change New Old % change Comments NII 22,210 25,687 (13.5) 23,795 28,383 (16.2) Lower NIMs and muted AUM PPOP 12,021 14,897 (19.3) 12,703 15,932 (20.3) growth to impact NII growth Provisions 902 1,771 (49.0) 1,136 1,156 (1.7) Asset quality held on well despite PAT 7,394 8,729 (15.3) 7,692 9,826 (21.7) sharp correction in gold price NIMs Cut in lending rates to impact lending yields 5 Edelweiss Securities Limited

6 Banking and Financial Services Muthoot Finance Q1FY14 earnings call takeaways Lot of negative perception about gold loan industry and regulatory headwinds, despite which PAT has sustained at INR 1.9 bn (down 22% YoY, 12% QoQ) Portfolio growth of 20% YoY (down 2% QoQ) to INR bn in Q1FY14. Quantum of gold pledged increased 2% to 137 tonnes (implying AUM/gm at INR 1,860) and average ticket size is INR 41 k. Consumers bringing in more gold. Number of gold loan account at 65 lacs (from 63 lacs in Q4FY13 and 55 lacs in Q1FY13). Going slow on branch expansion: added 80 branches. Adding branches in area where it is seeing some potential. Reduced lending rates in last 6-7 months and hence yields settled 200 bps lower at 19.5% In auction, there is no principal loss as such but due to decline in gold prices there would be relatively lower recoveries. INR 18 bn listed NCDs and INR 98 bn unlisted in form of Muthoot Gold Bonds. Planning to issue more listed securities: have already done 4 and will do 5 th soon in next couple of weeks (of INR 2 bn). Muthoot gold loan portfolio is INR 98 bn with duration of 5 years. Trimmed operating expenses by bps. Will have 1000 white labeled ATMs in first year, 2000 in 2 nd year and 6000 by 3 rd year. Outlook AUM growth estimated to be flat on conservative basis and 10% on optimistic front. Datapoints CAR: 20.77% Cost of borrowings has come off from 12.5% in Q4FY13 to 12.18% in Q1FY14. 6 Edelweiss Securities Limited

7 Muthoot Finance Q4FY13 earnings call takeaways Portfolio growth of 7% YoY to INR 260 bn in FY13. Quantum of gold pledged is 134 tonnes (implying AUM/gm at INR 1,940) and average ticket size is INR 41 k. With recent correction in gold prices, it has strengthened the collection mechanism by asking branches to engage more with the customers. Muthoot as a policy encourages regular servicing of loans. As a policy it goes slow on auction - it is an action of last resort. Therefore there has been an increase in GNPLs from 1.5% in Q3FY13 to 2% in Q4FY14. Does not indulge into hedging any part of assets. Increased standard asset provisioning from 0.25% to 0.3% to reach 0.4% as per Usha Thorat Committee recommendation. Recommended dividend of INR 4.5 per share. At present, maximum lending value per gram is INR 1,800. Outlook Expects 10% growth in AUMs in FY14 on a conservative note. Gross NPLs should stabilize by September Will open around branches in FY14. Have to bring down promoter shareholding to 75% by May Would like to leverage balance sheet upto 7.5x. Datapoints Interest accrued is INR bn on outstanding loan book of INR 260 bn (INR 7.5 bn in FY12 on AUM of INR 247 bn). Loans outstanding for more than 1 year would be less than 10%. 7 Edelweiss Securities Limited

8 Banking and Financial Services Company Description Muthoot is the largest gold financing NBFC with operating history of more than 70 years when M George Muthoot (the father of Promoters) founded a gold loan business in At present, it is a closely held family-owned business with promoters (sons of M. George Muthoot and their family) continuing to hold substantial stake of 80%. Headquartered in Kerala, the gold loan NBFC has a network of 4,163 branches, 65% located in southern India as of June, Muthoot has created leadership position in lending against gold jewellery with ~INR254bn AUMs (market share estimated at ~20% of the organised market, Source: IMaCS) comprising more than 60mn loan accounts. In addition to gold loan business, it also provides money transfer services through branches as sub-agents of various registered money transfer agencies, and recently has commenced providing collection agency services as well. Its other recent initiatives include sale of gold coins and insurance products amongst various other services. The Muthoot group has interests in a diverse range of business in areas of hospitality, media, education, healthcare, information technology etc. However, gold loans continue to be the mainstay and hence Muthoot Finance continues to be the flagship company. Investment Rationale Recent sharp correction in gold prices makes us vigilant on MUTH s asset quality and growth. Moreover, the company s borrowing profile will need transition in favour of bank borrowings and listed NCDs due to RBI s restrictions. While the gold loan industry is going through tough times, we believe MUTH will be able to transition well through this phase given its superior operations and strengthened collection. Key Risks Risk of ownership split in future between four promoter -brothers cannot be ruled out Gold loan dynamics of regions beyond South India is bit different Pressure on growth in case of slower ramp up of new branches or decline in gold prices Difficult to call an end of regulatory actions till final guidelines are out 8 Edelweiss Securities Limited

9 Muthoot Finance Financial Statements Key Assumptions Year to March FY12 FY13 FY14E FY15E Macro GDP(Y-o-Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Sector Credit growth Deposit growth Bank's base rate (%) Wholesale borrowing cost (%) G-sec yield Company Yield on advances Net interest margins Cost of funds Tax rate (%) Number of branches 3,678 4,082 4,382 4,682 Disbursement growth Gold loan tenure Securitised portfolio AUMs (in tonnes)/branch Average INR per gm 1,782 1,970 1,760 1,829 Average LTV Gross NPLs Prov Cov Income statement (INR mn) Year to March FY12 FY13 FY14E FY15E Interest income 45,280 53,641 50,874 52,944 Interest expended 23,699 28,194 28,664 29,149 Net interest income 21,581 25,447 22,210 23,795 - Fee & forex income Net revenues 21,791 25,677 22,460 24,060 Operating expense 8,129 9,667 10,439 11,357 - Employee exp 4,145 5,453 5,857 6,403 - Depreciation /amortisation Other opex 3,655 3,762 4,102 4,494 Preprovision profit 13,663 16,010 12,021 12,703 Provisions ,136 Profit before tax 13,312 15,114 11,119 11,566 Provision for tax 4,392 5,073 3,725 3,875 Profit After Tax 8,920 10,042 7,394 7,692 Reported PAT 8,920 10,042 7,394 7,692 Basic EPS (INR) Shares outstanding (mn) Diluted EPS (INR) Dividend per share (INR) Dividend payout (%) Growth ratios (%) Year to March FY12 FY13 FY14E FY15E Revenues (12.5) 7.1 NII growth (12.7) 7.1 Opex growth PPP growth (24.9) 5.7 Provisions growth Net profit (26.4) 4.0 Operating ratios Year to March FY12 FY13 FY14E FY15E Yield on advances Net interest margins Cost of funds Spread Cost-income Tax rate Edelweiss Securities Limited

10 Banking and Financial Services Balance sheet (INR mn) As on 31st March FY12 FY13 FY14E FY15E Equity capital 3,717 3,717 3,717 3,717 Reserves & surplus 25,540 33,639 39,476 45,638 Shareholders funds 29,257 37,356 43,193 49,355 Short term debt 131, , , ,463 Long term debt 62,417 72,267 67,844 73,484 Borrowings 193, , , ,948 Deferred tax liability (4) (4) (4) (4) Sources of funds 223, , , ,298 Total net fixed assets 2,682 3,030 2,895 2,780 Non current investments Current Investments Cash and equivalents 7,950 13,420 12,722 13,912 Loans and advances 214, , , ,234 Other current assets 7,412 13,023 11,952 12,232 Total current assets (ex cash) 230, , , ,377 Others current liabilities 10,700 12,559 12,742 12,933 Total current liabilities & 10,700 12,559 12,742 12,933 Net current assets (ex cash) 220, , , ,444 Uses of funds 223, , , ,298 Book value per share (INR) RoE decomposition (%) Year to March FY12 FY13 FY14E FY15E Net interest income/assets Non interest income/assets Net revenues/assets Operating expense/assets (3.8) (3.7) (3.9) (4.1) Provisions/assets (0.2) (0.3) (0.3) (0.4) Taxes/assets (2.1) (1.9) (1.4) (1.4) Total costs/assets (6.0) (5.9) (5.6) (5.9) ROA Equity/assets ROAE (%) Valuation parameters Year to March FY12 FY13 FY14E FY15E Diluted EPS (INR) Y-o-Y growth (%) (26.4) 4.0 Book value per share (INR) Diluted PE (x) Price/BV (x) Peer comparison valuation Market cap Diluted PE (X) Price/BV (X) ROAE (%) Name (USD mn) FY14E FY15E FY14E FY15E FY14E FY15E Muthoot Finance HDFC 21, Infrastructure Development Finance Co 2, LIC Housing Finance 1, Mahindra & Mahindra Financial Services 2, Manappuram General Finance Multi Commodity Exchange of India Power Finance Corp 2, Reliance Capital 1, Rural Electrification Corporation 2, Shriram City Union Finance Median AVERAGE Source: Edelweiss research 10 Edelweiss Securities Limited

11 Additional Data Muthoot Finance Directors Data M G George Muthoot Chairman George Alexander Muthoot Managing Director George Thomas Muthoot Whole Time Director George Jacob Muthoot Whole Time Director George Joseph Non-Executive Independent Director P George Varghese Non-Executive Independent Director John K Paul Non-Executive Independent Director K John Mathew Non-Executive Independent Director Auditors - Rangamani & Co. *as per last annual report Holding Top10 Perc. Holding Perc. Holding Baring India Investments 3.08 Matrix Partners India 2.06 Welcome Trust 1.95 Alliancebernstein LP 1.55 Merrill Lynch 1.49 Allard Growth Fund 1.01 Fidelity Management & Research 0.74 Sanford C Bernstein 0.49 BNP Paribas Asset Management 0.26 Parvest Investment Management 0.19 *in last one year Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *in last one year Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available *in last one year 11 Edelweiss Securities Limited

12 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Allahabad Bank BUY SP M Axis Bank BUY SO M Bank of Baroda BUY SP M Development Credit Bank BUY SO M Federal Bank BUY SO L HDFC HOLD SP L HDFC Bank HOLD SP L ICICI Bank BUY SO L IndusInd Bank BUY SP L IDFC BUY SO L ING Vysya BUY SO L Karnataka Bank BUY SO M Kotak Mahindra Bank REDUCE SU M LIC Housing Finance BUY SO M Magma Fincorp BUY SO M MMFS BUY SO M Manappuram General Finance BUY SP H Multi Commodity Exchange of India BUY SP M Muthoot Finance BUY SP M Oriental Bank Of Commerce BUY SO L Power Finance Corp BUY SO M Punjab National Bank HOLD SP M Reliance Capital BUY SO M Rural Electrification Corporation BUY SO M Shriram City Union Finance BUY SO M South Indian Bank HOLD SP M State Bank of India BUY SO L Union Bank Of India BUY SO M Yes Bank BUY SO M ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 12 Edelweiss Securities Limited

13 Muthoot Finance Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91-22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Co-Head Institutional Equities & Head Research Nirav Sheth Head Sales Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services Allahabad Bank, Axis Bank, Bank of Baroda, Development Credit Bank, Federal Bank, HDFC, HDFC Bank, ICICI Bank, Infrastructure Development Finance Co Ltd, IndusInd Bank, Karnataka Bank, Kotak Mahindra Bank, LIC Housing Finance, Multi Commodity Exchange of India, Manappuram General Finance, Magma Fincorp, Mahindra & Mahindra Financial Services, Muthoot Finance, Oriental Bank Of Commerce, Punjab National Bank, Power Finance Corp, Reliance Capital, Rural Electrification Corporation, State Bank of India, Shriram City Union Finance, South Indian Bank, Union Bank Of India, ING Vysya, Yes Bank Recent Research Date Company Title Price (INR) Recos 26-Jul-13 Shriram City Moderate growth: A desirable Union Finance strategy; Result Update 25-Jul-13 MMFS Momentum intact; Result Update 950 Buy 241 Buy 24-Jul-13 Yes Bank Improved business model limits downside; Result Update 383 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 1 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12-month period appreciate up to 15% over a 12-month period depreciate more than 5% over a 12-month period 13 Edelweiss Securities Limited

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