3QFY18 Result Update Institutional Equities Muthoot Finance 12 February 2018 Reuters: MUTT.BO; Bloomberg: MUTH IN Funding Cost Decline Combines With Operating Leverage Muthoot Finance (MFL) reported its 3QFY18 results with the key strategic pointers being: (1) MFL continues to adopt its differentiated approach to overdue customers. (2) MFL is a significant beneficiary of operating leverage. (3) MFL s cost of borrowing continues to decline (please see conference-call highlights). Per se, on the results front, MFL posted NII growth of 44% YoY to Rs10,538mn, PPOP growth of 73% YoY to Rs7,767mn and PAT growth of 59% YoY to Rs 4,637mn. We have marginally modified our legacy estimates for FY18/FY19 and retained Buy rating on MFL, decreasing our target price to Rs500 (from Rs633 earlier), valuing the stock at 1.8x FY20E P/BV. MFL opts for gold collateral auction only as an instrument of last resort: GNPA ratio of MFL rose to 5.6% from 4.6% in 2QFY18. The quantum and pace of stressed asset accretion seems optically high, but is the result of a deliberate strategy to delay the auction of gold collateral for overdue customers in order to maintain an ongoing relationship with them. The management stresses that loss given default in gold loan business remains minimal, regardless of high headline GNPA ratio. Nevertheless, credit costs rose to 80bps compared with 6bps in 3QFY17. MFL cost-to-income ratio declines 11% points YoY, indicating high operating leverage: MFL s cost-to-income ratio fell to 29% from 40% in 3QFY17 as opex growth of 7% lagged the 46% rise in total income, indicating high operating leverage. Branch count stands at ~4,300, which is significantly large and the moderate branch addition run-rate of ~150 per year over the past two years will roughly continue in FY19. Traction in online gold loans (OGL) is also encouraging with the share of OGL now at 16% of total gold loans. Despite AUM per branch at Rs65mn being materially higher than key peer Manappuram Finance (Rs 34mn), MFL s operating leverage is significant, given its large-sized branch network. Interest expenses have fallen 21% YoY due to continued decline in cost of borrowing: Average cost of borrowing for 3QFY18 at 8.6% was 196bps lower than in 3QFY17 and 11bps lower than in 2QFY18. Share of bank borrowing rose to 57.1% from 45.5% in 3QFY17, while the share of NCDs remained relatively stable - moving to 26.8% from 28.3%. The continued impact of the MCLR regime and MFL s AA rating on bank borrowing proved to be beneficial for MFL. The share of CP fell from 12.8% to 6.9% and makes MFL less susceptible to the impact from rise in market interest rates. Valuation and outlook: We have revised our legacy NII estimates by 22.1%/13.9% for FY18/FY19, our PPOP estimates by 37.5%/25.9% and our PAT estimates by 33.2%/23.8%, respectively. We have rolled forward our valuation of MFL based on FY20E financials, valuing the stock at 1.8x FY20E P/BV and decreasing our target price to Rs500 (from Rs633 earlier). BUY Sector: NBFC CMP: Rs422 Target Price: Rs500 Upside: 18% Shivaji Thapliyal Research Analyst shivaji.thapliyal@nirmalbang.com +91-22-6273 8068 Shreesh Chandra Research Associate shreesh.chandra@nirmalbang.com +91-22-6273 8028 Key Data Current Shares O/S (mn) 399.9 Mkt Cap (Rsbn/US$bn) 169.2/2.6 52 Wk H / L (Rs) 526/325 Daily Vol. (3M NSE Avg.) 758,157 Price Performance (%) 1 M 6 M 1 Yr Muthoot Finance (10.3) (7.5) 24.8 Nifty Index (1.7) 5.5 19.1 Source: Bloomberg Y/E March (Rsmn) 3QFY18 3QFY17 2QFY18 YoY (%) QoQ (%) Interest income 15,227 13,280 16,385 14.7 (7.1) Interest expenses 4,689 5,970 4,889 (21.5) (4.1) Net interest income 10,538 7,310 11,496 44.2 (8.3) NIM (%) 15.0 10.8 16.6 424bps (155bps) Fee & other income 440 184 314 139.1 40.1 Operating income 10,978 7,494 11,810 46.5 (7.0) Staff costs 1,790 1,734 1,884 3.2 (5.0) Other operating expenses 1,421 1,265 1,231 12.4 15.5 Total operating expenses 3,211 2,999 3,115 7.1 3.1 Cost to-income (%) 29.3 40.0 26.4 (1,077bps) 288bps Cost-to-AUM (%) 4.57 4.42 4.5 16bps 9bps Operating profit 7,767 4,495 8,695 72.8 (10.7) Provisions 565 39 1,169 1,348.7 (51.7) Credit costs (%) 0.80 0.06 1.68 75bps (88bps) PBT 7,202 4,456 7,526 61.6 (4.3) Tax 2,565 1,545 2,985 66.0 (14.1) -Effective tax rate 35.6 34.7 39.7 94bps (405bps) PAT 4,637 2,911 4,541 59.3 2.1 EPS (Rs) 11.6 7.3 11.4 59.3 2.1 BV (Rs) 194.8 162.3 183.3 20.0 6.3 AUM (Rsmn) 282,648 269,625 276,080 4.8 2.4
Institutional Equities Key conference-call highlights Non gold loan subsidiaries now contribute ~8% to group AUM and this is expected to rise to ~10% by FY18-end and to ~15% by FY19-end. Non-gold loan book could rise to Rs 50bn in about five years time. Belstar Microfinance will raise capital in due course and MFL will participate in the same. The first year premium raised by Muthoot Insurance Brokers is Rs590mn in 3QFY18 compared with Rs 440mn a year ago. The Sri Lankan subsidiary has not done that well because the Sri Lankan economy as such is not faring well and because of political problems there is an element of policy paralysis there. However, the quality of the loan book there is sound and, in any case, MFL s exposure is not large in the overall context. MFL has strengthened its collection team and also incentivised borrowers to repay through a cashback scheme wherein 5% of the interest repaid is paid back to the customer. The policy of providing more time to the customer to repay and not go in for auction has been kept keeping in mind the flexibility that the unorganised lending sector offers to gold loan borrowers. MFL has engaged film star Amitabh Bachchan as its all-india brand ambassador. The company has also become the principal team partner of IPL cricket team - Chennai Super Kings. MFL has given growth guidance of 15% plus for gold loan as well as non-gold loan businesses. For the Rs1mn plus ticket gold-backed SME business, MFL has been able to run up a Rs5bn loan book at the end of 3QFY18 compared with almost zero at the beginning of the quarter. NPA level at the end of FY18 may remain similar to 3QFY18 as MFL has not taken a call on gold auctions so far. Of the total GNPAs, about Rs 5bn is from the six-month loan category. The six-month loan category has a higher NPA ratio as customers do not tend to have the time to come to the branch in short time periods. For the Rs1mn plus gold-backed SME loans, the sales personnel are the same as for other gold loans. Their incentives are linked to the interest rate at which they bring customers. The headline interest rate, though, is 12%. MFL is still recognising NPAs on 120dpd basis. Interest accrued is Rs10.24bn. MFL is considering other businesses like two-wheeler loans and even four-wheeler loans. NIM of ~12% plus or minus 1% is sustainable from a long-term perspective. RoA of ~3.5% is sustainable from a long-term perspective. Further reduction in cost of borrowing of 10bps-15bps is possible from the current level. Gold auctions in 3QFY18 were to the extent of Rs2.69bn compared with Rs7.78bn in 2QFY18. GNPA ratio for home loan business is below 0.43%. MFL has not set up a dedicated collection team for this business. ~98% of interest income is pure interest and not from other sources like penalties, etc. 2 Muthoot Finance
May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 Institutional Equities May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 Exhibit 1: Financial summary Net interest income 25,552 33,609 41,523 43,271 47,499 Pre-provision profit 14,791 22,026 29,673 30,375 33,213 PAT 8,095 11,798 17,619 18,328 20,582 EPS (Rs) 20.3 29.5 44.1 45.9 51.5 BV (Rs) 140.8 163.1 198.8 235.6 277.5 P/E (x) 20.8 14.3 9.6 9.2 8.2 P/BV (x) 3.0 2.6 2.1 1.8 1.5 Gross NPAs (%) 2.9 2.1 5.0 3.0 2.5 Net NPAs (%) 2.5 1.7 4.1 1.9 1.5 RoA (%) 3.0 4.1 5.6 5.4 5.4 RoE (%) 15.1 19.4 24.4 21.1 20.1 Exhibit 2: Actual performance versus our estimates (Rsmn) 3QFY18 3QFY17 2QFY18 YoY (%) QoQ (%) 3QFY18E Devi. (%) Net interest income 10,538 7,310 11,496 44 (8) 9,385 12 Pre-provision profit 7,767 4,495 8,695 73 (11) 6,263 24 PAT 4,637 2,911 4,541 59 2 3,851 20 Exhibit 3: Change in our estimates Revised estimates Earlier estimates % revision FY18E FY19E FY18E FY19E FY18E FY19E Net interest income (Rsmn) 41,523 43,271 34,009 37,983 22.1 13.9 Net interest margin (%) 14.9 14.4 11.6 11.3 326bps 313bps Operating profit (Rsmn) 29,673 30,375 21,577 24,133 37.5 25.9 Profit after tax (Rsmn) 17,619 18,328 13,225 14,802 33.2 23.8 EPS (Rs) 44.1 45.9 33.1 37.1 33.2 23.8 ABV (Rs) 169.5 220.5 171.1 196.7 (1.0) 12.1 Exhibit 4: One-year forward P/ABV (x) 3.0 2.5 2.0 1.5 1.0 0.5 - P/BVPS +1 SD -1 SD -2 SD 3 Muthoot Finance
Institutional Equities Financials Exhibit 5: Income statement Interest income 48,129 56,547 60,706 64,401 71,514 Interest expenses 22,577 22,938 19,183 21,130 24,015 Net interest income 25,552 33,609 41,523 43,271 47,499 Non-interest income 621 920 772 786 904 Net revenues 26,173 34,529 42,295 44,057 48,403 Operating expenses 11,382 12,503 12,622 13,682 15,190 -Employee expenses 6,419 7,280 6,877 7,362 8,238 -Other expenses 4,963 5,223 5,745 6,320 6,952 Operating profit 14,791 22,026 29,673 30,375 33,213 Provisions 1,625 2,816 2,143 1,738 1,053 PBT 13,167 19,210 27,530 28,637 32,160 Tax 5,072 7,412 9,911 10,309 11,578 PAT 8,095 11,798 17,619 18,328 20,582 Exhibit 7: Balance sheet Share capital 3,990 3,995 3,995 3,995 3,995 Reserves & surplus 52,202 61,170 75,423 90,145 1,06,880 Networth 56,192 65,165 79,418 94,140 1,10,875 Borrowings 1,85,669 2,09,855 2,16,443 2,37,976 2,78,483 Other liability & provisions 28,626 32,111 27,588 23,626 19,300 Total liabilities 2,70,487 3,07,131 3,23,450 3,55,742 4,08,658 Fixed assets 2,273 2,182 2,400 2,640 2,904 Investments 983 2,091 2,091 2,091 2,091 Loans 2,43,355 2,72,199 2,85,809 3,14,390 3,61,548 Cash 6,791 15,343 17,149 18,863 21,693 Other assets 17,085 15,316 16,001 17,758 20,422 Total assets 2,70,487 3,07,131 3,23,450 3,55,742 4,08,658 Exhibit 6: Key ratios Growth (%) Net interest income 18.1 31.5 23.5 4.2 9.8 Operating profit 38.9 48.9 34.7 2.4 9.3 Profit after tax 20.7 45.8 49.3 4.0 12.3 Business (%) Advances growth 4.2 11.9 5.0 10.0 15.0 Spread (%) Yield on loans 20.2 21.9 21.8 21.5 21.2 Cost of borrowings 11.9 11.6 9.0 9.3 9.3 Spread 8.3 10.3 12.8 12.2 11.9 NIM 10.7 13.0 14.9 14.4 14.1 Operational efficiency (%) Cost to income 43.5 36.2 29.8 31.1 31.4 Cost to assets 4.8 4.9 4.5 4.6 4.5 Productivity (Rsmn) AUM per branch 57.0 63.2 72.7 83.6 96.1 AUM per employee 10.7 11.2 12.8 14.4 16.3 Employee per branch 5.3 5.6 5.7 5.8 5.9 CRAR (%) Tier I 20.9 21.8 25.3 27.2 27.9 Tier II 3.6 3.1 3.4 3.4 3.5 Total 24.5 24.9 28.7 30.7 31.4 Asset quality (%) Gross NPAs 2.9 2.1 5.0 3.0 2.5 Net NPAs 2.5 1.7 4.1 1.9 1.5 Provision coverage 14.5 18.1 18.0 36.0 40.0 Credit costs (excluding std. assets) 0.2 0.1 0.7 0.5 0.2 Credit costs(including std. assets) 0.7 1.1 0.8 0.6 0.3 Return ratios (%) RoE 15.1 19.4 24.4 21.1 20.1 RoA 3.0 4.1 5.6 5.4 5.4 Per share (%) EPS 20.3 29.5 44.1 45.9 51.5 BV 140.8 163.1 198.8 235.6 277.5 ABV 125.8 151.6 169.5 220.5 264.0 Valuation (x) P/E 20.8 14.3 9.6 9.2 8.2 P/BV 3.0 2.6 2.1 1.8 1.5 P/ABV 3.4 2.8 2.5 1.9 1.6 4 Muthoot Finance
Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Institutional Equities Rating track Date Rating Market price (Rs) Target price (Rs) 7 November 2016 Buy 345 525 15 November 2016 Buy 340 530 15 February 2017 Buy 335 525 22 May 2017 Buy 379 535 10 August 2017 Buy 457 590 10 November 2017 Buy 491 633 Rating track graph 550 500 450 400 350 300 250 200 150 Not Covered Covered 5 Muthoot Finance
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