Post the pandemic induced cash crunch, and rising gold prices, the gold financing industry witnessed healthy tailwinds. Muthoot Finance, which is a leading player in gold loans, grew its gold loan book by 27 per cent year on year (yoy) in FY21 to ₹51,926.6 crore. While it is set to benefit further from the current low penetration of gold financing, the company has also witnessed heightened competition from banks and new fintech players.
Amidst this changing environment, Muthoot has been able to compete well to a large extent , although this has led to a contraction in yields in the June 2021 quarter, which is expected to continue over the near term. However, impact on margins can be largely contained by likely reduction in cost of funds.
Despite the near term aberrations in margins, the stock continues to be a good bet for the long term, given its strong business fundamentals and its balance sheet strength that can help sustain pressures from competition. Besides its dominant share in the formal gold financing market, negligible loan write offs in the past, collateral cushion (LTV of 60 per cent), low ticket size and shorter repayment tenures, have worked well for the company. These positives in the business model have helped translate the high yields into higher returns for shareholders – return on assets of 8 per cent and return on equity of 27.8 per cent in FY21. The company also sits on healthy buffers -- capital adequacy ratio was at 27.3 per cent in June 2021.
Since our previous call last year (published on October 19, 2020 edition) , the stock is up 28 per cent. It currently trades at 3.9 times its June 2021 book value, which is 22 per cent above its 3-year average multiple of 3.2 times. Given the run-up in the stock (trading just 6 per cent below its lifetime high), investors may make use of the market volatility to buy the stock, instead of adding in one go. .
Its peer Manappuram Finance is comparatively smaller and has less exposure to gold loan, only 66.5 per cent are gold loans of overall book of ₹24,800 crore as of June 2021. It has slightly lower financial metrics (RoA and RoE of 5.6 and 26.2 per cent, respectively in FY21). Manappuram stock trades at 2.26 times its June 2021 book.
Near-term pressure
According to the World Gold Council, while Indian consumers have USD 1.5trillion of gold (mostly jewelry), gold financing penetration is just about 10 per cent . Despite only 35 per cent of the financing being done through the formal sources (banks and NBFCs), these are set to benefit better from the increasing penetration, given the competitive pricing and institutional safety that they offer to the customers. Within the formal segment, Muthoot has more than 10 per cent market share in gold loans (compared to leading banks such as SBI and Indian Bank whose gold loan portfolio constitutes less than 5 per cent market share each).
Despite banks trying to ramp up their gold loan portfolios and many fintech players entering the gold financing market, Muthoot has been able to hold its turf. This was possible through its presence in unbanked towns (65 per cent of its branches are in rural areas), its institutional pedigree and digital offerings (such as loans at doorstep, digital on-boarding and payment options). About 28.5 per cent of the company’s gold loan customers transact online currently.
While the company’s loan book continued to grow at 27 per cent in June 2021 quarter as well, the intensifying competition has led to a contraction in yields (down 195 basis points yoy). Net interest margins however, only dropped by 101 basis points to 12.9 per cent due to reduction in cost of funds (down 94 basis points).
Going ahead while we expect lower yields to continue, margins may be cushioned further from likely revision in cost of funds. With a diversified borrowing profile – 30 per cent from NCDs and bonds, 44 per cent from banks and financial institutions and 16 per cent from external commercial borrowings—the company may benefit further from the continuing low interest rate environment.
Other positives remain
Benefitting from the highly liquid nature of the collateral attached, and the low loan to value ratio (LTV) maintained by the NBFC — 50-60 per cent on the overall book, the company loan write offs have been negligible. Its stage -3 assets have also been low, on the back of lower ticket size of loans, and flexible repayment options. As of June 2021, the gross stage 3 assets (Ind AS equivalent of GNPA) were at 1.22 per cent of the gross loan book, compared to 2.56 per cent in the year ago period.
Besides, its falling operating expenses has further aided its profits. The operating expenses as a percentage of loan assets, which hovered above 5 per cent since March 2014, dropped to sub 4 per cent in March 2021 (further down to 3.21 per cent in June 2021 quarter).
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 10 per cent to the consolidated loan assets of the company, which stood at ₹ 58,134.8 crore as of end of June 2021 quarter. These contribute to less than 3 per cent of the consolidated profits of the company, which was ₹978.6 crore in the recent June quarter (Consolidated revenues for the quarter were at₹2963.4 crore).