Subscribe to Muthoot Finance IPO - Ajcon Global

Key positives

Underpenetrated gold loans market, rural India to drive growth

India is one of the largest markets for gold and as of fiscal 2010, accounts for ~10% of the total world gold stock with an annual demand for ~700 tonnes. (Source: IMaCS Industry Report -2010). Lending against gold has been one of the most popular instruments based on gold, and it works well with the Indian rural population, which typically views gold as an important savings instrument that is liquid and can be converted into cash instantly to meet their urgent cash requirements. Rural India is estimated to hold ~65% of the total gold stock. The organized gold loans portfolio accounted for merely 1.2% of the value of total gold stock in India.

Gold loans market in India was estimated at ~Rs.350-400bn which has witnessed a CAGR of 40% over the period 2002-2010. The gold loans market is significantly under penetrated and is expected to grow at rate of 35-40% in the future. (Source: IMaCS Industry Report – 2010 update).

Moreover, traditionally gold owners in southern India are more open than elsewhere in the country to accept and exercuise the option of pledging gold to borrow money (Source: IMaCS Industry Report – 2009).

The company has a dominant presence in Southern India which augurs well for the company as it is the largest market accounting for ~40% of the gold demand.

Market leading position in Gold Loan business, early mover advantage and strong brand

MFL has been the leader in gold financing business with 20% share as on FY10. The other players in this segment with major market share are Indian Overseas Bank (20%) and Indian Bank (10%).

The company due to its early entry has built a recognizable brand in the rural and semi–urban markets of India, particularly in the southern Indian states of Tamil Nadu, Kerala, Andhra Pradesh and Karnataka. This has led to strong distribution network. As on March 31, 2010 and November 30, 2010, the southern Indian states of Tamil Nadu, Kerala, Andhra Pradesh, Karnataka and Union Territory of Pondicherry constituted 75.4% and 75.3%, respectively of its gold loan portfolio.

Diversifying presence

The company has predominantly been a south based player. The company is now diversifying its presence in Northern and Western India. Its efforts of diversifying presence have been evident through its reducing branch concentration in South to 70% in FY10 from 85%.

Strong capital raising ability

MFL raises funds at relatively competitive rates from banks and institutional investors. It enjoys high credit ratings of LAA- and A1+ from ICRA, which support its ability to raise funds at competitive rates. In addition, the strong franchise and the group's long track record in Kerala enable MFL to tap retail funding sources (accounting for about 33% of total funding in September 2010). As on December 2010, the capital adequacy of MFL was at 15.19% (Tier 1 of 10.69%). The company raises subordinate debt (which classifies as Tier 2 capital, subject to a maximum of 50% of Tier I capital) placed primarily to its retail investors. MFL currently has limited headroom to raise additional Tier 2 capital in the form of subordinate debt but has headroom (of Rs. 5.9bn) to raise Tier 2 capital in the form of preference shares to meet its regulatory capital adequacy requirements of 15% (with effect from March 2011). Proposed IPO would create additional headroom for MFL to raise Tier 2 capital, thereby expanding its capacity to lend.

High margin of safety enjoyed by MFL in gold financing business

It provides loan which is ~70-80% of the asset value, average maturity of loan is~4-5 months and smaller ticket size loans (average ticket size Rs.31,553/-) leading to higher response time. On account of this, there are no calls for margin payments to clients, in the event of decline in gold prices. Over the last three years, the company has not more than 3% of gold against loans outstanding has been auctioned. This is primarily on account of gold ornaments being pledged by families where huge sentiments are involved leading to higher recovery of loans.

Key risks

MFL loan portfolio not classified as priority sector advances by the RBI

A recent notification issued by the RBI in February 2011, has stipulated that loans sanctioned to NBFCs for on lending to individuals or other entities against gold jewellery would not be eligible for classification as priority sector advances in the context of priority sector lending guidelines issued by RBI. Accordingly, its ability to raise capital by selling down its gold loan portfolio under bilateral assignments will be hampered in the future and impact its ability to raise funds through loans from banks, which may adversely affect its financial condition.

Major concentration in southern India

As on February 28, 2011, 1753 out of its 2,611 branches are located in the southern states of Tamil Nadu (593 branches), Kerala (607 branches), Andhra Pradesh (316 branches), Karnataka (230 branches) and Union Territory of Pondicherry (7 branches). Moreover, southern states as on November, 2010 accounted for 75.28% of its total gold loan portfolio. Any slowdown in the southern Indian economy could affect business and profitability.

Exposed to an event risk – Kerala Money Lender's Act

MFL is exposed to an event risk- 'Kerala Money Lender's Act' (KML), which empowers the state government to regulate lending rates of money lenders operating in the state and requires money lenders to register branches with the state authorities apart from other things. The matter is subjudice at the Supreme Court. Any adverse ruling in this case could impact the growth prospects of the company in the state of Kerala, which accounted for around 16% of its portfolio as on September 30, 2010. However, the impact on asset quality may not be significant as the company can auctions the pledged gold ornaments.

Outlook and recommendation

We believe the stock valuation of P/BV – 3.2x at the upper end of the price band of Rs. 175 is justified, because of the following reasons:

a) MFL being the market leader in gold financing business,
b) Early mover advantage in gold financing business and strong brand in southern India,
c) Strong fund raising capabilities at competitive rates,
d) Diversifying presence in northern and western parts of the country,
e) CRISIL and ICRA rating of 4, indicating above average fundamentals,
f) Larger presence (2,611 branches) with a higher scale in terms of gold loan portfolio of Rs.128.9bn as compared to its peer Manappuram General Finance Ltd. (MGFL) with 1,800 branches and gold loan portfolio of Rs.65bn,
g) No offer for sale by PE players and Preferential allotment to private equity players(Matrix Partners India Investments, LLC and The Wellcome Trust) on September 23, 2010 at Rs.173.5 instills confidence and provides a comfort on the valuation front.

We recommend 'SUBSCRIBE' to the issue for short term listing gains.

Source : Equity Bulls

Keywords