Stock Call. Why the stock of Muthoot Finance is a good buy

With most lenders having turned cautious, bank credit growth has been subdued since April 2020. In the recent months, however, gold loans and unsecured personal loans are the only segments that have seen a steady growth.

Gold loan-focussed NBFCs such as Muthoot Finance and Manappuram Finance retained their healthy growth rates in the recent quarters. Their AUMs (assets under management) grew by 15 per cent and 25 per cent (y-o-y), respectively, in the first quarter of FY21.

With the pandemic leaving many individuals and small businesses cash-strapped, this credit line was comparatively easier to tap. Rising gold prices, flexibility in repayment, low turnaround time and vast reach of gold-loan NBFCs are among the reasons that helped bolster the credit growth for gold-loan NBFCs.

For lenders, too, factors such as low-ticket size, high liquidity of collateral and shorter tenure of loans abated fears of payment default on part of the borrowers.

Given the tailwinds for the industry, it might be worthwhile for investors to consider adding gold financiers to their portfolio.

In our view, Muthoot Finance (Muthoot) seems a good long-term bet considering its healthy growth in loan book, sound asset quality, good return ratios and better liquidity and capital profile than most banks and NBFCs.

After witnessing a steep correction in the market carnage in March 2020, the stock more than doubled in just about three months. The company is the largest player in the organised gold-lending market with a share of about 19.2 per cent. At the current market price, the stock trades at 3.2 times its FY21 book value per share (Bloomberg consensus estimates).

Given its dominance in the gold loan industry and better financial metrics, Muthoot trades at a premium to Manappuram Finance (one-year forward price to book of two times). However, the stock is trading at a discount to Bajaj Finance that operates in consumer durable finance (shorter average tenure and ticket size similar to Muthoot) — currently trading at about five times its FY21 book value per share.

Better financial metrics

Muthoot Finance carries out its gold loan business predominantly through its standalone entity.

The company has seven subsidiaries (including an overseas NBFC) which are into the businesses of home finance, vehicle finance, micro finance, insurance broking and other forms of lending. The subsidiaries contribute about 12 per cent to the consolidated loan assets of the company, which stood at ₹46,871 crore as of end of FY20.

These contribute to less than 5 per cent of the consolidated profits of the company.

The company’s AUM (standalone) grew by 19 per cent CAGR over FY18 to FY20 to ₹40,772 crore as on March 31, 2020.

Given its strong yields on advances (more than 20 per cent since 2018) and gradual drop in borrowing costs (due to better borrowing mix), the company has been able to maintain healthy margins of over 14 per cent for the last two-three years. The net interest margin stood at 15.5 per cent in FY20.

Profits grew by 30 per cent CAGR over FY18-20 to ₹3,018 crore.

No lockdown blues

With the nation under lockdown for most part of the first quarter of FY21, the loan assets of the company (though up 15 per cent y-o-y), declined by about 1 per cent from the March 2020 quarter levels. The management reported that while repayments continued to flow in as usual, average monthly disbursements dropped to ₹6,900 crore in the June quarter compared with ₹9,800 crore in March quarter. However, owing to a fall in borrowing costs, the company saw a 22 per cent y-o-y increase in its net interest income in the June quarter. That apart, with a 19 per cent y-o-y decline in operating expenses, the profits of the company surged by 59 per cent (y-o-y) to ₹841 crore.

In the wake of the pandemic, high proportion of loans under moratorium for banking and finance companies is a worry for investors.

Muthoot Finance, however, has largely remained unaffected — given the shorter tenures of loans offered, the management has reported that hardly any customers have opted for the loan moratorium.

Collection efficiency was, however, hit, which also led to a marginal increase slippages in the first quarter of FY21. In the recent June quarter, the average monthly collections dropped to ₹7,000 crore (from ₹8,700 crore in March 2020), and the Gross stage-3 assets (GNPA equivalent under Ind-AS) increased to 2.56 per cent from 2.16 per cent in March 2020.

However, what is comforting is the historically low ratio of bad loans written off (has remained at sub 1 per cent) by the company. This proportion stood at 0.14 per cent of total loan book in FY20. This comes on the back of the highly liquid nature of the collateral attached, lower ticket size of loans (average of ₹53,000) and the low loan to value ratio (LTV) maintained by the NBFC — 54 per cent on the overall book.

Apart from the low LTV, shorter tenure of loans (most loans have a maximum tenure of 12 months) also helps protect the company’s loan book against any sharp correction in the prices of gold, which would be a key risk for the company. The company also has a healthy capital buffer (capital adequacy ratio of 26.3 per cent as on June 30, 2020) and sound asset liability management (ALM) profile.

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