Pick of the Week 12 Jun 2017

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Muthoot Finance Ltd
Industry CMP Recommendation Add on Dips to band Sequential Targets Time Horizon
BFSI Rs. 447 Buy at CMP and add on declines Rs. 412-418 Rs. 506 & Rs. 546 2-3 quarters

We had issued Stock Note dated 19th May 2016 at the then CMP of Rs. 218 and had recommended to buy at CMP and add
HDFC Scrip Code MUTFINEQNR
on dips to Rs. 196-204 with price targets of Rs. 243 and Rs. 258. Both the targets were met in the month of June 2016 and
BSE Code 533398 the stock recently made a high of Rs. 439.30 on 5th June 2017. Refer:
NSE Code MUTHOOTFIN http://old.hdfcsec.com/Research/ResearchDetails.aspx?report_id=3017761. We now review the developments in the
company and provide our updated view on the stock.
Bloomberg MUTH IN
Company Description
CMP as on 09 Jun 17 447.10
Muthoot Finance Ltd is India’s largest, niche gold finance company with an AUM of ~Rs273 bn in March 2017.
Eq. Capital (Rs cr) 399.54 Headquartered in Kochi (Kerala), the company is majority owned by the Muthoot family (73.7% stake as of March 2017). It
Face Value (Rs) 10 currently has 4,307 branches and presence across 29 states/union territory in the country. However, its footprint is
concentrated mostly in the South with ~62% of the branches. While loans are typically disbursed with tenure of 6-12
Equity Sh. Outs (Cr) 4.00 months, most of the loans are repaid within six months – implying average duration of close to six months for the loans.
Market Cap (Rs cr) 17863
Investment Rationale:
Book Value (Rs) 140.83  Demonetization blues waning away, growth to resume
Avg. 52 Week Vol 875000  Rating upgrade and softer interest rates to bring down cost of borrowing
 Strong performance at subsidiaries – derisking dependence on gold loans
52 Week High 452.90
 Improving asset quality to keep provisioning requirement at lower levels
52 Week Low 250.00
Concerns:
 Increase in NPA
Shareholding Pattern-% (Mar-2017)  Gold price fluctuations
 Interest rate risk
Promoters 73.71
 Overdependence on Gold loans – derisking to reduce dependence slowly.
Institutions 21.66
Financial Summary
Non Institutions 4.63 (Rs Cr) Q4FY17 Q4FY16 YoY (%) Q3FY17 QoQ (%) FY16 FY17 FY18E FY19E
Total 100.0 NII 1150 865 32.9 725 58.5 2542 3346 3369 3851
PPP 885 585 51.2 503 76.0 1479 2184 2177 2558
Research Analyst: Atul Karwa PAT 385 265 45.0 348 10.4 810 1162 1296 1541
EPS (Rs) 9.6 6.6 44.8 8.7 10.4 20.3 29.1 32.5 38.6
[email protected]
P/E (x) 22.0 15.4 13.8 11.6
P/ABV (x) 3.6 2.9 2.6 2.2
RoAA (%) 3.0 4.0 4.0 4.2
(Source: Company, HDFC sec)

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Recent updates/triggers
Demonetization blues waning away, growth to resume
The demonetization of currency announced by the Government in Nov-16 impacted the business of the company as a
significant portion of loans and repayments were done in cash. AUM declined sequentially by ~2% in Q3FY17 but picked up
by 1.2% in Q4FY17. For the year, AUM increased 12% yoy to Rs 27279 cr. Management has guided for a minimum growth of
10% in gold loans on a steady state basis and a consolidated growth of 15% in loans.

Rating upgrade to bring down cost of borrowing

In Aug 2016, ICRA upgraded long term debt rating of Muthoot Finance from AA-/Stable to AA/ Stable. The upgrade reflects
the resilient business risk profile of Muthoot Finance as demonstrated during the past few years during which the gold loan
sector went through challenging times, and the company’s strong earnings profile. The rating upgrade also factors in a
stable operating environment with an established regulatory regime. Further Muthoot is replacing its higher cost
debentures issued in earlier years at interest rates of ~11% with new debentures at a cost of ~9.5%.

Interest rates in the system have also come down post demonetisation. Although interest rates have inched up post Dec
2016, they are still lower on a YoY basis. Muthoot Finance will get benefit of these going forward.

Ratings upgrade combined with lower borrowing costs would bring down the overall cost of borrowings and lead to margin
expansion. The full impact of lower cost borrowings will come in H1FY18.

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Strong performance at subsidiaries – Derisking dependence on gold loans

Muthoot is looking to scale up its non-gold business from ~5% of consolidated business in FY17 to 9-10% by FY18 driven
mainly by the home loan business.
 Muthoot Homefin’s loan portfolio stood at Rs 441 cr at the end of FY17 as compared to Rs 32 cr in FY16), with
operations in Kerala, Maharashtra, Gujarat, Rajasthan and Madhya Pradesh. Home loan business posted total revenues
of Rs 24 cr and PAT of Rs 0.3 cr. The company is targeting home loan portfolio of Rs 1500 cr and Rs 3000 cr in FY18 and
FY19. Average home loan size stood at Rs 11 lakhs, entirely in the affordable housing sector. Muthoot owns 88.27% in
the subsidiary.
 Belstar Investment & Finance, microfinance subsidiary of Muthoot (64.6% stake) posted a 114% yoy growth in its loan
portfolio to Rs 567 cr. It has doubled its presence from 76 branches in FY16 to 155 in FY17 across 5 states (Tamil Nadu,
Karnataka, Madhya Pradesh, Maharashtra and Kerala) and 1 Union Territory (Pondicherry). PAT for the year stood at Rs
1 cr as compared to Rs 0.6 cr in FY16 with GNPAs and NNPAs of 0.09% and 0.02%, respectively.
 Muthoot Insurance Brokers became a wholly owned subsidiary of Muthoot Finance in June 2016 and is actively
distributing both life and non-life insurance products of various insurance companies. During FY17 it collected first year
premium of Rs 70 cr as compared to Rs 48 cr in FY16 and 35 cr in FY15. It reported a PAT of Rs 0.6 cr.
 Muthoot holds 60% stake in Sri Lanka based Asia Asset Finance which is involved in Retail Finance, Hire Purchase &
Business Loans and has 15 branches across Sri Lanka. AAF’s loan portfolio grew by 26% yoy to Lankan Rs 866 cr. It
reported PAT of Lankan Rs 28 cr against Lankan Rs 18 cr in FY16.

Belstar Inv. & Muthoot Asia Asset

Rs Cr Muthoot Finance Muthoot Homefin
Finance Insurance Brokers Finance*
Year FY17 FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 FY16
Loan AUM/Premium 27279 24379 441 32 567 264 70 48 363 288
Total Revenues 5747 4875 24 2 103 58 12 10 89 58
PAT 1180 810 3 0 10 6 6 5 12 7
* Converted at 1 LKR=0.42 INR (Source: Company, HDFC Sec)

NIMs likely to stabilize at current levels

Muthoot reported elevated NIMs for FY17 at 12.7% against 10.5% in FY16. Higher NIMs were on account of change in
income recognition policy wherein the company recognized accrued interest of Rs 374 cr in Q4FY17 which were earlier
being recognized on receipt basis. Excluding the additional recognition, calculated NIMs were in the range of ~11.5%, an
expansion of 100 bps yoy. We expect NIMs to stabilize ~11.5% levels going forward.

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Reported NIMs likely to stabilize ~11.5% levels

(Source: Company, HDFC Sec)

Improving asset quality to keep provisioning requirement at lower levels

Muthoot’s GNPA declined from 2.9% at the end of Q3FY17 to 2.1% at the end of Q4FY17 as it was able to auction the
overdue accounts without any losses. NNPA also fell from 2.5% to 1.7%. Asset quality has been the best in the last 9
quarters. The company has utilized the one-off increase in interest income on account of change in income recognition on
the recommendation of Income Tax authorities, to create a gold price fluctuation provision of Rs.233 cr which should help
the company in case of extreme volatility in gold prices. Management is not very concerned about NPAs since they have
more than 100% collateral in the form of gold which can be auctioned without any loss to the company.

Asset quality has been the best in the last 9 quarters

(Source: Company, HDFC Sec)

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Increasing use of technologies to bring down costs

From being a mere "gold evaluation centre", Muthoot's branches have transformed into a vibrant business centres.
Responsibility of employee has been expanded from mere valuation of gold ornaments to sourcing of business, local
marketing and collection of overdue interest. Also, Muthoot has been at the forefront of adapting to new age technologies
by launching online gold loan product through web and app. 84% of new KYCs are done through e-KYC. Loan proceeds are
directly credited to bank account. It has introduced Gold Cash Card wherein the loan amount is loaded in card which can be
used at ATMs and shopping. This also eliminates the need to have a bank account. More than 10% of its active gold loan
customers are transacting online. All these measure would reduce cash handling at its branches and improve efficiency
thereby bringing down operating expenses.

Q4FY17 Result Review

Net interest income increased by 32.9% yoy to Rs 1150 cr in Q4FY17 aided by volume growth and one off impact of interest
income recognition of Rs 374 cr. Borrowing cost also declined by ~70 bps sequentially resulting in higher net interest
margins. Non-interest income declined 23.3% yoy to Rs 17 cr. Assets under management increased by 12% yoy to Rs 272
bn. Asset quality improved as collection efficiency returned to normal post the impact of demonetization in Q3FY17. GNPA
declined by 86 bps qoq to 2.1% while NNPA were lower by 77 bps at 1.7%. The company utilized the one-off interest gains
towards creating a gold price fluctuation reserve of Rs 233 cr. PAT increased by 45% yoy to Rs 385 cr. Management has
guided for consolidate loan growth of 15% for FY18 with share of non-gold loans increasing to 9-10% from 5% currently.

Particulars Q4FY17 Q4FY16 YoY (%) Q3FY17 QoQ (%) FY17 FY16 YoY (%)
Interest Income 1696 1429 18.7 1322 28.3 5640 4801 17.5
Interest Expenses 546 564 -3.2 597 -8.5 2294 2258 1.6
Net Interest Income 1150 865 32.9 725 58.5 3346 2543 31.6
Non interest income 17 22 -23.3 24 -28.8 107 74 44.1
Total Income 1167 887 31.5 749 55.7 3453 2617 31.9
Operating Expenses 282 302 -6.6 246 14.5 1030 1158 -11.0
PPP 885 585 51.2 503 76.0 2423 1459 66.0
Prov & Cont 233 110 111.6 0 NA 268 143 87.7
Profit Before Tax 652 475 37.3 503 29.6 2155 1317 63.7
Tax 268 210 27.5 155 73.1 741 507 46.1
PAT 385 265 45.0 348 10.4 1414 810 74.6
EPS 9.6 6.6 44.8 8.7 10.4 35.4 20.3 74.4

GNPA (%) 2.1 2.9 -82 bps 2.9 -86 bps 2.1 2.9 -82 bps
NNPA (%) 1.7 2.5 -77 bps 2.5 -85 bps 1.7 2.5 -77 bps
(Source: Company, HDFC sec)

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Concerns
Increase in NPA
This risk denotes the possibility of loss due to the failure of any counterparty to abide by the terms and conditions of any
financial contract. This risk is mitigated by a rigorous loan approval and collateral appraisal process, strong NPA monitoring
and collection strategy. This risk is further diminished because the gold jewellery used as collateral for loans can be readily
liquidated.

Gold price fluctuations

This risk arises from the decline in the value of the gold collateral due to fluctuation in gold prices. However, this risk is in
part mitigated by at least 25% margin retained on the value of jewellery for the purpose of calculation of the loan amount,
i.e. the company lends maximum of only 75% of the value of jewellery (current Loan to value ratio is 67%). Further, risk is
reduced because the price of gold jewellery is higher given that the production costs, design cost and the gemstones
associated with making the item is not considered for arriving at the value of jewellery for the calculation of the loan
amount. Having said that, gold prices do have an impact on the Gross NPA ratios of Muthoot Finance.

When gold prices are on up move, GNPA is low and vice versa as shown in the chart above. But the management is of the
view that the gold prices would going forward remain steady and would not be very volatile.

Global and Domestic gold prices have been on an uptrend in the last 6 months
1-GOLD.GOLD 10 GRMS.R.MCX.Rolling - 08/06/17 Trend7
37 T
36500
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35500
35 T
34500
34 T
33500
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32500
32 T
31500
31 T
30500
30 T
29500
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25500
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24500
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23500
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S N J13 M M J A O D F14 A J A S N J15 M M J A O D F16 A J J S N J17 M M Weekly

(Source: Kitco, MCX, HDFC Sec)

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Interest Rate Risk

This risk reflects potential losses arising from the movement in interest rates. To avoid excessive exposure of Muthoot’s
earnings and equity to loss and to reduce its exposure to the volatility inherent in financial instruments, majority of the
company’s borrowings, and all the loans and advances it makes, are at fixed rates of interest. This minimises the company’s
interest rate risk.

Overdependence on Gold loans – diversification to take time to make a difference

Even in FY18, MFL is targeting just 9-10% of its AUM coming from non gold loan segments. Given the large AUM of Gold
loans, the non gold loan portfolio will take time to reach a decent proportion of the overall AUM.

Liquidity Risk
Liquidity management is to ensure sufficient cash flow to meet all financial commitments and to capitalise on opportunities
for business expansion. The nature of business is such that source of funds, primarily proceeds from issue of debentures
and bank loans has longer maturities than the loans and advances given resulting in low liquidity risk.

View and Valuation:

Over 2012-2016 the gold loan industry has been dragged down by various regulatory pressures. With a more stable
regulatory environment, healthy RoE, expected improvement in RoA, low asset quality risk and a gradual pick-up in loan
growth in the medium term, we believe Muthoot’s valuations are quite attractive. While recent growth rates were
impacted by demonetization, current valuations leave room for improvement if the rural economy and SME/trade
community see better times and its growth rate breaks into higher trajectory.

MFL has utilized one-off recognition of higher income to create a gold price fluctuation provision, excluding which its ABV
would have been higher by ~Rs 6. The company has the highest rating among gold loan companies for short term paper. Its
capital adequacy of 24.9% (March 2017) is well above the regulatory minimum of 15%. The subsidiaries are profitable and
are witnessing strong growth. While we do not assign any value to these businesses yet, they could contribute meaningfully
in years to come.

Gold loan companies even after the recent run up quote at a discount in terms of P/ABV compared to other categories of
NBFCs like Housing finance, Personal/durable finance, micro finance. This is despite the fact that the possibility of NPAs in
this segment is the lowest. While growth in AUM is lesser than those in the other segments, the diversification by these
companies into other segments via subsidiaries could overcome this constraint. Expectation of good monsoon this year
could trigger larger demand for gold loans across the country (especially in the south). We think the gap in the valuations of
gold loan companies could narrow going forward.

We feel investors could buy the stock at the CMP of Rs 447 (2.2x FY19E ABV) and add on declines to Rs. 412-418 band
(2.05x FY19E ABV) for sequential targets of Rs. 506 (2.5x FY19E ABV) and Rs. 546 (2.7x FY19E ABV) in 2-3 quarters.

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Peer comparison (Standalone-FY17)

CMP Mcap Gold Loan AUM NII PAT EPS ABV P/E P/ABV RoNW
(Rs) (Rs Cr) (Rs Cr) (Rs Cr) (Rs Cr) (Rs) (Rs) (x) (x) (%)
Muthoot 447.1 17863 27220 3346.0 1179.8 29.5 151.8 15.1 2.9 18.1
Manappuram 94.8 7982 11125 2004.5 726.0 8.6 36.5 11.0 2.6 21.9

Financial Statements

Income Statement Ratio Analysis

(Rs Cr) FY15 FY16 FY17P FY18E FY19E Particulars FY15 FY16 FY17P FY18E FY19E
Interest Income 4261 4800 5640 5900 6603 Return Ratios
Interest Expenses 2106 2258 2294 2531 2752 Calc. Yield on adv 18.7% 20.0% 21.7% 20.2% 20.1%
Net Interest Income 2155 2542 3346 3369 3851 Calc. Cost of borr 10.8% 11.9% 11.6% 11.3% 11.0%
Non interest income 64 75 89 108 131 NIM 9.5% 10.6% 12.9% 11.5% 11.7%
Operating Income 2218 2617 3435 3477 3982 RoAE 14.3% 15.1% 19.1% 18.5% 19.0%
Operating Expenses 1153 1138 1250 1300 1424 RoAA 2.6% 3.0% 4.0% 4.0% 4.2%
PPP 1065 1479 2184 2177 2558 Asset Quality Ratios
Prov & Cont 37 162 282 199 223 GNPA 2.2% 2.9% 2.1% 2.1% 2.3%
Profit Before Tax 1028 1317 1903 1978 2335 NNPA 1.9% 2.5% 1.7% 1.7% 1.9%
Tax 357 507 741 682 794 Growth Ratios
PAT 671 810 1162 1296 1541 Advances 7.0% 4.2% 11.8% 13.0% 12.0%
Borrowings -0.2% -4.5% 13.6% 12.3% 11.2%
Balance Sheet NII -4.9% 18.0% 31.6% 0.7% 14.3%
(Rs Cr) FY15 FY16 FY17P FY18E FY19E PPP -13.9% 38.9% 47.7% -0.3% 17.5%
Share Capital 398 399 399 399 399 PAT -14.0% 20.7% 43.5% 11.5% 18.9%
Reserves & Surplus 4686 5220 6117 7101 8307 Valuation Ratios
Shareholder funds 5084 5619 6516 7501 8707 EPS 16.8 20.3 29.1 32.5 38.6
Borrowings 19436 18567 21096 23695 26339 P/E 26.5 22.0 15.4 13.8 11.6
Other Liab & Prov. 2250 2862 3101 3428 3808 Adj. BVPS 116.7 125.8 151.8 174.4 202.1
SOURCES OF FUNDS 26769 27049 30713 34623 38853 P/ABV 3.5 3.2 2.7 2.4 2.0
Cash & Bank Balance 264 227 218 225 223 Dividend per share 6.0 6.0 6.0 6.5 7.0
Investment 38 98 209 310 416 Dividend Yield (%) 1.3 1.3 1.3 1.5 1.6
Advances 1737 679 1534 1549 1735 Other Ratios
Fixed Assets 23539 24524 27424 30989 34708 Cost-Income 52.0 43.5 36.4 37.4 35.8
Other Assets 1191 1520 1327 1549 1770
TOTAL ASSETS 26769 27049 30713 34623 38853

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One year Forward PABV One year Price chart

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Fundamental Research Analyst: Atul Karwa, [email protected]

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