Manappuram Finance - 3Q earnings call takeaways - Unusual but not sinister - Ambit

Post a disappointing 3QFY13 results wherein MGFL's net profit declined 22% QoQ and 48% YoY basis to Rs844mn, we sought further clarity from the management on the income reversal of ~Rs390mn that hit the profitability during the quarter. As per the management, company auctioned ~2.0 tones jewelry during the quarter against a delinquent loan portfolio originated mostly in Aug'11 with principal outstanding of ~Rs3.6bn. As some part of this portfolio had LTV ratio of ~90% at the time of origination, the proceedings from the auction of jewelry was not enough to cover the principal and accrued interest on this portfolio (a shortfall of R390mn).

Since the annualised interest charged on such loans was ~32% (including penal interest), the accumulated interest on these loans over the five quarters was ~40% of the initial outstanding principal. Given that the LTV was as high as 90% at the time of origination and gold prices increased only by ~10% between August 2011 and December 2012, the proceedings from the auction were not enough to cover the principal and accrued interest on this loan portfolio of ~Rs2bn (~2% of the disbursals made in 2QFY12).

The management expects another hit of ~Rs350mn during the next quarter from this legacy high LTV portfolio but expects no additional hits from 1QFY14 onwards. Note that the company's peak LTVs have dropped to ~75% from 4QFY12 onwards due to an LTV cap by the regulator.

Where do we go from here? Whilst interest income reversals are a part of the gold lending business because of agreed tenure of the loans being ~12months and bullet payment nature of the re-payments, it's impact was not visible in the profitability of MGFL historically because: (i) the loan book was doubling every year and hence the disbursals made a year ago were a smaller part of the total loan book, (ii) gold prices were rising rapidly and hence were enough to cover the principal and thus it accrued interest despite higher LTVs, and (iii) the auctioning process was much easier for the company. However, the company's loan book has been declining over the past one year, gold prices are stagnating, and the RBI has made auctioning more cumbersome and hence, the impact on profitability has been more pronounced. With the peak LTVs being ~75% at present and lending rates coming down to ~24%, such one-time hits on profitability would decrease in the future.

Whilst we do not share the management's optimism (on 3Q earnings call) on 25% loan growth, 4% RoA and ~22% RoE in FY14, the company has the potential to deliver RoAs of ~3.0-3.5% and RoEs of 18-20% from FY15 onwards once the liability side eases and loan growth returns. Note that Manapurram Finance's (MGFL) current cost of borrowings is ~200bps higher than similar-sized NBFCs, and its opex-to-average-asset ratio at ~5.6% is around ~170bps higher than its competitor Muthoot Finance, due to lower loans for each branch. Moreover, the final report on gold loan NBFCs published by the RBI is incrementally positive for the company. The Committee has recommended cheque transactions and PAN card requirement for loans above Rs0.5mn (vs Rs0.2mn in the draft report) and has asked the RBI to look at opening alternative sources of borrowings (securitisation, ECB borrowings, etc.) for gold loan NBFCs. Our earnings estimates and target price in this note are our last published estimates on the stock. We may reduce our earnings estimates by 5-10%, which could result in a similar reduction in our target price for the company. However, we would maintain our BUY stance on the stock, because at 1.2x current BVPS, the risk-reward is favourable.

Source : Equity Bulls

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