Leadership status to ensure brighter future of Muthoot Finance Limited

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Being the largest and the lowest cost lender, the impact of regulatory and gold price changes was slightly lower than Manappuram. Nonetheless, Muthoot Finance had its own share of problems. Growth suffered, auctions increased and interest income losses in these auctions pressurized profitability. Like Manappuram, Muthoot Finance too re-engineered its business process and activated its employee force. However, it has not yet switched to shorter tenure products. Instead, they have chosen to wait and watch the customer behaviour in response to Manappuram’s new products.
This leads us to believe that auction losses for Muthoot Finance may continue for a slightly longer time. Nevertheless, its cost leadership and strong retail franchise will ensure that it is able to maintain current level of profitability and grow in future. Valuations at 1.2x FY17e book are inexpensive.
Lowest lending rates among NBFCs a step in the right direction
The management believes that being the lowest interest rate gold loan NBFC will enable it to win the trust of the customer and eventually translate into market share gains. Muthoot Finance lends at an average rate of 21% versus the second and third largest NBFCs lending at 23% each. The initial signs were encouraging: AUM grew 10% over the past three quarters at the time when most other banks are struggling to maintain their gold loan portfolios.
We believe most other NBFCs have high cost structures and will not be able to lower rates to such an extent. This could make Muthoot Finance the preferred lender in the gold loan space and the prime beneficiary of an economic revival as and when it happens.
Low valuations despite leadership status, offers a positive opportunity to accumulate
Given its leadership position in gold loans and the low cost advantage, Muthoot Finance will be the largest beneficiary as when there is revival in the broad economy. Its huge retail franchisee comprising of over 4,200 branches and 23,000 employees would ensure 10% growth in the current environment and over 15% growth in case of an economic revival. It is well positioned to increase its business by 25% without incurring any significant increase in operating costs.
We build in a modest 11% loan book CAGR over FY15-17 due to weak demand environment and static gold prices. Most of the yield adjustments are over and margin should stabilise ~9%. Current valuations at 1.2x FY17e book are attractive given its leadership status and strong returns profile. We maintain our BUY recommendation with a target price of INR230 per share.

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