Muthoot Finance

Sharing my deep dive into Muthoot vs Manappuram for the benefit of VP community here. :

I recently started looking at a business model that has been in existence since the past 100+ years and has shown consistent profitable growth since at least the last 10 years (that’s the period I have studied for this post) – it is that of Gold Loan financing. And there are 2 listed pure-play Gold loan financing companies in India (Muthoot Finance & Manappuram) which I have studied for this post.

Disclosure : I am invested in these companies so the views shared below are biased. Please do your own due diligence before investing.

First, let me briefly explain the framework I have used for this business-cum-stock analysis – it is called “QGLP” and is fantastically described by Mr. Raamdeo Agrawal of Motilal Oswal Securities in this note from Page 28 onwards (https://www.motilaloswal.com/site/rreports/637443115602580742.pdf). QGLP is short for Quality, Growth, Longevity & Price and these 4 factors together help decide whether a business is fit for investment or not.

Quality comes from Return on Equity being higher than Cost of Capital and the business being able to reinvest its earnings at the same or higher RoE. Business should be run by able management as well.

Growth in Earnings or Book Value Per share and Free Cash Flow.

Longevity i.e. there should be a long runway of quality growth ahead for the company.

Price i.e. the valuation that Mr. Market is assigning to the business at the moment and whether that valuation is cheaper than quality and growth metrics of the business warrant.

Why is Gold Loans a Quality business?

• Short tenure (6 months) & secured Loans with highly liquid collateral (Gold Loan companies auction off the borrowers’ gold in case they don’t pay for 3 months)
• 20% yield (significantly higher than the Cost of funds) resulting in double digit NIMs (in the range of 10-12%)

Exhibit 1: Muthoot Yield, CoF, NIMs (Manappuram NIMs are in the same range)

• Both point 1 & 2 above translate into high (20%+) Return on Equity and 6% Return on Assets (there have been 2 periods in which RoE and RoA declined – first, during 2012-14 when adverse regulations were introduced by RBI, and second, post-COVID when competition from banks intensified)

Exhibit 2: RoE and RoA trend

• 60-70% Loan to Value (LTV) ratio helps cushion against decline in Gold price
• Barriers to entry – Banks find it difficult to compete with specialised Gold Loan NBFCs because the business is operationally intensive – valuation, safekeeping & auctioning of gold on a large scale requires a specialised focus which banks and diversified NBFCs find challenging to build.
• Unorganised to Organised shift in market share – Traditionally local moneylenders have exploited borrowers with very high interest rates and no safety of Gold kept with them. Branded players offer safety, reasonable interest rates, flexible payment options and digital convenience that local moneylenders can’t match.
• Low Non Performing Assets (NPAs) – default rates are low because Indians are emotionally attached to their jewellery.
• Doesn’t need external equity capital to grow because of high RoEs so existing equity shareholders are not diluted; internally generated funds & borrowings are sufficient to fund growth and both these companies pay handsome dividends as well because of strong Free cash flow generation.

Quality of Management – Although this is purely a judgement based factor, one way to judge the quality of management is to look at how well it responds to threats to its business. During 2012-14, India’s central Bank RBI introduced stricter regulations to curb supernormal Gold Loan growth and global Gold prices tanked because of Fed’s taper tantrum. Stock prices of both these companies nosedived.

Exhibit 3: Regulations introduced by RBI (Source: IDBI capital research report)

After this episode, management of both GL companies decided to de-risk their Gold dependency by diversifying into other products like Microfinance Loans, Home Loans, Vehicle loans etc.

Exhibit 4: Diversification journey post 2014

Management of both GL companies has also tried to improve operational performance by

• increasing Gold Loan AUM per branch, and
• lowering Opex to AUM %age

Muthoot is much better than Manappuram on operational front.

Exhibit 5: Operational performance metrics

Growth

Gold Loan Assets Under Management (AUM) growth is driven by 2 factors:

1. Gold price which has grown at a CAGR of 6.6% pa over the last 10 years broadly in line with inflation in India.
2. Volume growth (Gold in tons) which is in the range of 3.5-4% pa over the last 10 years

Exhibit 6: Volume growth

Both these factors combined have helped deliver 8-9% growth in Gold Loan AUM in the last 10 years.

Exhibit 7: Gold AUM growth linked to Gold price growth

Exhibit 8: Book Value per share has grown in double digit CAGR in last 10 years

Longevity

• Needless to say, Indians love their Gold. Gold demand by Indians based on World Gold Council numbers is steady over the last 10 years and as per estimates, 40% Gold stock is concentrated in South India where both the pure-play GL companies are based.

Exhibit 9: Gold demand in India as a %age of Global Gold demand is ~20% making India one of the biggest consumers of Gold apart from China

• Plus, the penetration of Gold loans as a %age of Gold stock in India is very low at around 4-5%.
• Another factor is share of the Organised sector in Gold Loans is still low but growing. Most of the branches of these 2 companies is in Tier 2 and Tier 3 cities i.e. rural India which makes up bulk of our unbanked population, and where people still invest in Gold, and people don’t have proper documentation to avail a loan from a bank in case of need.

Price

Price to Book ratio is the most relevant valuation metric for finance companies.

Manappuram P/B is at 10 year low maybe because the market is spooked by rising competition from banks and other NBFCs! (Source: screener.in)

Muthoot P/B is close to its median over last 10 years due to similar fears

Muthoot vs Manappuram: Muthoot is more richly valued (P/B of 2x) vs Manappuram (P/B of 1x) but that premium might be justified because of several comparative metrics we have seen above; Muthoot is better than Manappuram in terms of:

• GL AUM growth, BVPS growth
• Operational performance,
• RoE, RoA
• Leveraging scale (per branch GL AUM is growing faster for Muthoot coz of greater focus vs Manappuram which is focused on growing other products)
• Lower diversification (helps Muthoot coz gold loan yields are higher vs other products into which both these companies are diversifying)
• Muthoot’s management has a greater stake in success of the business (73% of INR 400Bn) vs Manappuram’s management (32% of INR 80Bn)

What are the key risks in this business?

1. People shifting their investments from Physical Gold to “Digital Gold” – this risk is a bit muted because Physical Gold serves a bigger purpose (like jewellery) than pure investment instrument and people with cash income have limited avenues to invest through regular banking channels.
2. Regulatory risks in terms of LTV, capital requirements etc which impacts AUM growth
3. Banks/other NBFCs offering Gold Loans at a lower interest rates to grab market share (though 2 banks – CSB and SBI – who have aggressively built their GL book during COVID are reeling now with high NPAs)
4. GLs are short term loans so GL companies have to constantly hunt for new customers as old loans get repaid. This creates an operational challenge.
5. Risk of fraud/theft, employee strikes, flooding in key states which ruins crops and disrupts business activity.
6. Govt hiking import duty on Gold like it did in Jul’22 from 10% to 15% on the back of all time high Gold imports. This makes Gold bit more expensive and dampens demand.
7. The required cultural mindset shift which is required to grow GL penetration from 4-5% might never happen (as people are reluctant to pawn their Gold as it’s considered a sign of respect and is attached to people’s emotions).