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Muthoot Finance Ltd IPO Review (Apply)

Review By MLR Securities Private Ltd on Apr 16, 2011

Issue Date: April 18 - April 21
Price Band: Rs 160 - 175
Market Cap (Rs Cr): 5,947 - 6,505
Issue Size (Rs Cr): 824 - 901
No of Shares (Cr): 5.15
GreyMarket Premium(Rs): 32-35

Muthoot Finance Ltd is a non-deposit taking NBFC in the business of lending against household used gold jewellery to individuals. Muthoot Finance’s operating history has evolved over a period of 70 years since Mr M George Muthoot founded a gold loan business in 1939. MFL received the NBFC licence from the RBI in 2001. The NBFC has the largest branch network among gold loan providers in India with 2,611 branches and a strong presence in under-served rural and semi-urban markets in India with total Assets under Management of Rs 12,897 Cr as of November 2010.

During 2010, the company received fund infusion amounting to Rs 2.5 bn from private equity players like Baring India Private Equity, Matrix Partners India, Kotak India Private Equity Fund and Wellcome Trust for a 6% stake in the company. Further, in 2011 Wellcome Trust picked up additional 1% stake from the promoters, taking the total stake of private equity investors to 7% in the company. The NBFC raised Rs 130 Cr from 11 Anchor investors at Rs 170/share. The anchor investors include Citigroup, Goldman Sachs, Credit Suisee amongst others.

Muthoot Finance’s AUM increased at a CAGR of 74% from Rs 8 bn in FY06 to Rs 74 bn in FY10 driven by a rise in pledged gold and a significant spurt in gold prices.

On the back of growth in AUM, interest income increased at a CAGR of 66% from Rs 1.4 bn in FY06 to Rs 10.8 bn in FY10. Profit after tax (PAT) improved from Rs 271 mn to Rs 2,276 mn in FY10.

The adjusted EPS and adjusted book value of the company increased at a CAGR of 53% and 43% respectively over FY06-10. Gross NPAs have been contained to less than 0.5% in the past three years. Muthoot Finance enjoys a strong capital to risk adjusted ratio (CRAR) of 15% which is in excess of the RBI’s requirement of 12%.

The company frequently sells its portfolio under bilateral direct assignments which also helps it keep its capital ratio strong. In 2010, the company raised Rs 2.5 bn from private equity players, which will help it shore up capital base and fund its growth.

Financials (Rs in Cr) FY08 FY09 FY10 8mFY11
Gold AUM 2,179.00 3,300.10 7,341.70 12,897.70
Gold Volume Pledged (tons) 30.00 39.00 66.00 97.60
Interest income 357.90 606.20 1,077.50 1,289.35
Interest expense 179.80 309.80 473.70 582.56
NII 178.10 296.50 603.80 706.79
Other Income 10.70 14.20 11.90 123.17
Net Profit 63.60 97.70 227.60 291.48
Adjusted EPS (Rs) 2.60 3.50 7.60 7.84
Adjusted Equity Shares (In Cr) 24.60 28.00 30.10 37.17
Net Worth 213.10 361.40 584.20 2,032.25
Adjusted Book Value 8.70 12.00 19.40 54.67
RoE (%) 34.00 34.00 48.00 51.00
RoA (%) 3.00 3.00 5.00 2.90
Gross NPA (%) 0.42 0.48 0.46 0.35
CRAR (%) 12.60 16.30 14.80 15.06
NIMs (%) 9.70 10.60 11.20 10.40

Valuations

Muthoot Finance’s market cap is coming to Rs 5,847 Cr – Rs 6,505 on a price band of Rs 160 – Rs 175. The company is asking for a price to earnings multiple of 13.6-14.9 times its annualized FY11 EPS of Rs 11.7 which is at a discount to Manappurram General Finance despite the former having a higher market share of 20% while Manappuram just has a market share of 6.8% as on FY10. The price to book value is 2.9-3.04 times its post issue book value which is at marginal premium to Manappurram General Finance.

FY10 (Rs Cr) Total Income Net Income Est Gold Loans Portfolio Market Share (%) Mcap Annualised EPS (Rs) P/E (x) P/BV (x)
Manappuram General Finance 478 120 2560 6.8 5292 5.8 22.4 2.8
Muthoot Finance 616 229 7342 19.5 5947-6505 11.7 13.6-14.9* 2.9-3.04*

Key Positives

Muthoot – Established Brand
MFL has an established track record in the niche Gold loan segment, and has a gold loan portfolio of Rs. 12,897 Cr as on November 30 2010. The Muthoot Group enjoys strong market knowledge and a good franchise in southern India on the back of significant experience of the promoters of the Group since 1939. An early entry in this business, not only in South India but also in other regions, has helped the company develop a strong brand image, wide distribution network and AUM. The growth of the company is also aided by the fact that gold loans are commonly accepted form of financing amongst households in southern India.

Niche Business Model
MFL is the largest player in the niche business of gold financing, both in terms of AUM and distribution network. The gold loan asset class is characterised by small ticket size loans secured against gold ornaments. The average ticket size is of around Rs 30,000 for MFL. While the contractual tenure of the loan contract is 12 months, the loan tenure is typically around 3-4 months. MFL’s AUM has grown at a four-year CAGR of 74% to Rs 74 bn in FY10. The company has grown its market share by 9% during FY07- FY10 backed by its strong presence in the South India Market.

 

Gold Loans Provider Estimated Gold Loans Portfolio (Rs Bn) Gold Loans Market Share (%)
FY08 FY08 FY09 FY10 FY08 FY09 FY10
Muthoot Finance 14.2 33 73.4 11 13.4 19.5
Muthoot Fincoro 4.7 11.8 22.2 3.6 4.8 5.9
Manapurram 4.8 12 25.6 3.7 4.9 6.8
Indian Bank 17 32.5 39.2 13.2 13.2 10.4
Indian Overseas Bank 16.9 31 52.2 13.1 12.6 13.9
Federal Bank 6 10.7 8.6 4.7 4.3 2.3
South Indian Bank 6 15 23.5 4.7 6.1 6.3
State Bank of Travancore 11.4 16 19.3 8.9 6.4 5.1
Andhra Bank 4 9 14 3.1 3.6 3.7

 

Robust Industry Outlook
According to the IMACs industry report, based on the assessment of the emerging dynamics and competitive landscape, the Gold Loans market is expected to grow at between 35% and 40% over the next three years. Moreover, as the market is currently under-penetrated, it is expected that the Gold Loans market will offer enough opportunities for portfolio expansion and retain attractive margins for all existing specialized NBFCs, banks and new entrants. The branch expansion and marketing initiatives of various specialized NBFCs are anticipated to give a strong boost to the acceptability of Gold Loans and lead to further growth in the Gold Loans market.

Healthy Asset Quality
Muthoot Finance has maintained strong asset quality supported by its comfortable loan-to-value (LTV) ratio at origination, robust systems and processes, and the highly secured nature of the LAG business. Strong underwriting standards have resulted in very low gross non-performing assets (NPA) of 0.46% for the company. Sentiment attached to the household ornament also support low NPA.

The company's track record of collections in the gold loan segment has been good, and has been supported by good portfolio monitoring systems; borrower's sentimental attachment towards the pledged gold ornaments and rising gold prices. The company monitors the market value of the outstanding security against each of its contracts; and has the option to auction gold ornaments in case borrowers fail to repay their loans.

Also, the ultimate losses have been lower; it has incurred credit losses lower than Rs 30 mn over the past seven years, out of cumulative disbursement of more than Rs 590 bn. Gold loan is provided on the basis of weight of the gold ornaments excluding cost of studded stones and making charges for the ornament which further lowers the LTV of the loan. Such factors along with sentiment attached to ornaments discourage customers from defaulting.

Asset Quality FY08 FY09 FY10 8mFY11
Gross NPAs 9.30 16.10 34.40 46.10
Provisions 0.90 1.60 3.70 5.00
Net NPAs 8.30 14.50 30.60 41.10
Net Retail Loans 1792.20 2556.00 5429.80 9757.20
Net NPAs/ Net Retail Loans (%) 0.50 0.60 0.60 0.40
Gross Retail Loans 2226.30 3369.00 7438.20 13003.70
Gross NPAs/ Gross Retail Loans (%) 0.40 0.50 0.50 0.40

Diversified Sources of Funds
Muthoot Finance has access to a diversified resource profile. As of FY10, it had a total debt outstanding of Rs 52 bn. Its established track record helps to mobilise funds from retail investors by issuing non convertible debentures (NCD) through its branches offering interest rates of 11-11.5%.

Stringent Internal Controls System
The internal audit team of the company consists of 500 members and is spread out in different locations. The company conducts regular audits of branches to check the efficacy of the gold assessment quality of the branches and other operational processes of the branches. MFL is exposed to operational risks, as its transactions mainly involve gold jewellery and cash. MFL maintains its gold ornaments in strong rooms that are insured against fire, theft and employees frauds. The company is also in the process of rolling out the installation of CCTV zacross its branch network in order to reduce the risk of theft.

Risks

Downturn in Gold prices
A significant rise in gold prices along with the increase in loan requirement by customers has boosted Muthoot Finance's AUM. Any sharp fall in gold prices could pose challenges. However, Muthoot Finance has a comfortable LTV ratio in line with other gold financing NBFCs ranging from 60-85%, which helps it to combat the downside in gold prices. Also, the shorter tenure of gold loans (usually ranging from three to six months) offers flexibility of resetting the LTVs.

Business Concentration in the Southern India
Muthoot Finance derives 98% of revenues from the gold loan business. Also, it is expected to remain concentrated in South India, which accounts for 75% of AUM for the short to medium term despite aggressive growth plans in the northern and western states.

Royalty Payment to Promoters
The company has a royalty clause which is not implemented yet, in favour of promoters for allowing the company to use the Muthoot trademarks, which is fixed at 1% of the annual income, subject to a maximum of 3% of annual profit.

Regulatory Hitches
The impact of the State Money Lenders Act for NBFCs, the decision on which is awaited from the Supreme Court, could not only adversely affect Muthoot Finance's lending rates but also increase its operational expenditure, given the requirements (under the act) of registering all establishments with state authorities and complying with state regulations. The decision of the Supreme Court regarding this issue remains a sensitive factor for the company. In addition, extension of regulatory restrictions on securitization to bilateral direct assignments being adopted by the company can be a hurdle. Also, any cap on interest rates can adversely affect the company's performance.

We believe that RBI's recent directive for removal of priority sector lending (PSL) benefit available to commercial banks, under agriculture classification, for gold loans to (and assignment portfolios from) gold loan companies would adversely affect the company leading to an increase in borrowing cost and a moderation in return ratios.


Conclusion / Investment Strategy

We recommend investors to Subscribe the issue considering its established track record in the loan against gold business, strong fundamentals, robust industry outlook and decent valuations makes it an attractive investment bet for a long term horizon.

Reviewer recommends Subscribing to the issue.

Review By MLR Securities Private Ltd on Apr 16, 2011

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