Manappuram Finance Limited - De-risking of business model still sometime away - Antique

We met the management of Manappuram and conducted few branch visits to understand the changing business dynamics post the profit warning issued by the company last week. ICRA, one of the leading rating agencies, has conducted a stress test on the Manappuram's portfolio and concluded that the company's capital adequacy is sufficient to maintain A+ credit rating even in the event of a 15%-18% decline in gold prices. While this allays the fear of a liability squeeze, we also visited some branches to understand if the appraisal methods used at branches are robust. Our interactions reveal that the acid tests used at branches don't help in differentiating between a 20k and a 22k jewellery and this is a skill that the valuer has to develop. Our assessment is that some of the valuers at the 1000+ new branches that were opened over FY11 and FY12 wouldn't have had the requisite skill, thus leading to inadvertently high LTVs.

Appraisal risk real, evolving mitigation measures necessary

Although our interaction with branch staff suggests that they are not completely equipped to differentiate between 19k, 20k, 21k or 22k gold jewellery, the company maintains that the gold valuation done in its 3000+ branches is robust and chances of large scale deviations are low. The checks and balances have evolved over time and the current techniques deployed include 1) loans above INR10,000 are appraised by 2 people; above INR20,000 by 3 people and so on, 2) Generally, they do not accept 18k jewellery. In case of doubt, they will reduce the "net grammage" i.e 50gm of 18k gold will be treated as 40gm of 22k gold, and 3) Region based hair-cut system. As an illustration, purity levels of gold in Mumbai area is high while it is low in tier-2 or tier-3 town. Manappuram will have a higher "grammage" hair cut in such areas.

Re-affirmed credit ratings from ICRA - a positive

ICRA has recently concluded its preliminary evaluation of the potential losses that can arise in case of a gold price decline and has re-affirmed the credit ratings of its long-term and short-term credit facilities at A+ (Stable). Important observations include 1) available capital cover is sufficient for current rating levels if gold prices were to correct 15%-18% from the current prices, 2) Around INR18.5bn of un-utilised bank lines would support its liquidity position, and 3) market risk for gold loan companies has increased as they need to hold the security over a longer tenure to comply with the stringent guidelines on auctioning. CRISIL is conducting a similar exercise and is shortly expected to come out with its view.

Our view - cautious in the near term

We will remain cautious till the portfolio originated prior to Feb'12 completely runs off. The key reason for that being our belief that large scale branch expansion and loan book growth at 80%+ LTVs in FY12 could have been accompanied significantly lower appraisal standards as well (given that large portion of valuation experts are most new branches were graduates or under-graduates will little experience in that domain).

Source : Equity Bulls

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