Muthoot Finance - Strong Buy/Outperformer Rating with Target Price of Rs 185 - Edelweiss Report

Edelweiss Report has come out with a report on the Gold Loan Industry, which states that despite the regulator cracking whip on the gold loan business, the near term challenges, the business model is here to stay.

The Edelweiss report in its Executive Summary has said, "FY13 will be the year of consolidation for gold finance companies in term of growth and margins though stability at the ground level might surprise the consensus numbers and expectation. From FY14 onwards, the business model would deliver steady state of 15-20% growth, impressive return profile (ROA of 3.5-4.0% and ROE of 20-25%) and benign asset quality metrics, a key investor pull. We prefer to play this space via quality players like Muthoot Finance (initiating with BUY/Sector Outperformer and TP of INR185, valuing it at 1.5x FY14E book).

The Report also has come out with an Initiating Coverage on Muthoot Finance and put a 'Buy & Outperformer' rating with a target price of Rs 185, indicating a 31% upside.

Given below is the investment rationale for Muthoot Finance in the report:

Muthoot Finance (Buy/Outperformer)

Recent RBI guidelines may have ensnared the gold rush for gold loan NBFCs, materially altering their business dynamics. But for Muthoot Finance (Muthoot), India's largest gold loan NBFC with INR244bn AUM, the business model is as good as gold given its leadership in this niche business, created meticulously through conservative practices. We visited Muthoot branches across the country and conclude that post the 60% LTV cap, even though the business momentum has slowed, growth and margin profile is much better than envisaged earlier. Expecting Muthoot to generate a steady RoA/RoE of 3.5%/25%+, we believe 1.1x FY14 P/B prices in many concerns. We initiate coverage with a 'BUY/Sector Outperformer' recommendation and a TP of INR 185 (31% upside). Risks are further adverse regulatory actions or decline in gold prices.

New regulations take sheen off industry, but Muthoot can cope better

Muthoot's average LTV before RBI norms stood at 70% while other players and new entrants had higher LTVs (up to 80-85%), employed to gain market share. Given the 60% cap, Muthoot's quality aspects like branch locations, brand value and employee quality will further polish its market leadership.

Seasoned player: Best in class productivity, risk management

With a fleet of experienced employees and easily accessible branches, productivity is high at INR 66mn AUM/branch, well ahead of the competition. With 56% of 3,678 branches being added over past two years, optimum operating leverage is yet to flow in. Auctions at mere ~0.5-1% of AUM for last 4-5 years reflect sound risk management.

Outlook and valuations: Valuation prices in risks; initiate with 'BUY'

The current fiscal will be a year of consolidation for the industry as well as Muthoot (flat AUM and earnings growth). However, post the consolidation phase (FY14 onwards), we expect it to retrace back to 20% growth profile with RoA/RoE in excess of 3.5% / 25%. Branch visits makes us more confident on merit of Muthoot's business model and execution capabilities. Our earning estimates are 13% ahead of consensus. We initiate coverage with a 'BUY/Sector Outperformer' with TP of INR 185.

Source : Equity Bulls

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