Buy Manappuram General Finance-; Robust earnings but RoEs capped now;: Emkay

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Manappuram General Finance

Robust earnings but RoEs capped now

BUY

CMP: Rs 91                                        Target Price: Rs 120

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n     Earnings traction remains strong with 142% growth in NII and 129% growth in PAT but regulatory headwinds to impact return ratios going forward

n     We believe that the increase in the costs is manageable (50-150bps) due to loss of PSL status but capital requirement to put cap on RoEs at 21%

n     We estimate AUMs of Rs120bn for FY12E compared with management guidance of Rs150bn. Inability to raise capital or fall in gold prices are key risk to our call

n     Valuations at 2.0x/1.4x FY11/FY12E P/ABV attractive but RoEs capped at 21%. With sharp price correction, we upgrade our rating to BUY from HOLD with TP of Rs120

Q3FY11 continue to show strong traction…

MAGFIL’s Q3FY11 NII of Rs2.3bn was inline with expectation, as the same grew by

30.2% qoq driven by 31.5%qoq growth in AUMs, albeit NIMs declined by 40bps qoq to

14.2%.

…As business growth continues to be robust…

The company’s AUMs grew by a robust 31.5% qoq to Rs65.2bn in Q3FY11 led by 36%

qoq growth in gold loans. The AUM for Q3FY11 also include assignment portfolio of

Rs14.2bn.

… And asset quality stable

The asset quality remain stable with Gold loan Net NPA at 0.14% (0.11% in Q2FY11).

However the provisioning was higher during the quarter as the bank provided Rs125mn

(0.25% of standard assets) for standard asset provisioning as mandated by RBI.

Pace of branch addition to slow down going forward

MAGFIL has grown its branch network at an aggressive pace over the last few years.

However the management indicated that the pace of branch addition will slow down

considerably in FY12. The company plans to add 500 branches in FY12 as against 1000

branches opened in FY11.

Costs increase for PSL loans can be taken in stride

Recently, the RBI issued guidelines removing (1) loans sanctioned to NBFCs for on-lending

to individuals or other entities against gold jewellery and (2) investments made by banks in

securitised assets originated by NBFCs, where the underlying assets are loans against gold

jewellery from the category of loans to agricultural sector.

Manappuram had ~20% of the portfolio in securitised segment as on Dec-10 (now ~17%)

which is at ~<8% yield and 50% of the residual portfolio falls under the PSL on-lending by

the banks. Back of the envelope calculations suggest that the increase in costs (assuming

300bps rise in costs) could be ~144bps. Over past one year MAGFIL has already reduced

its lending rates to less than 24% which can be increased to pass on the costs now that its

borrowings may not fall under PSL.

Differential can be even lesser if MAGFIL borrows short term

The cost increase can be even lesser if MAGFIL borrows short term. While the average

repayment pattern of MAGFIL’s loans is about 90-100 days, the assignment happens for

period of one year. Accordingly if MAGFIL borrows on 90-100 days commercial paper, the

cost would be ~9% compared to <8% yield on assignments. In such scenario, the increase

in the cost of funds will be just ~50bps.

No cap on yields is a reprieve

The approach of RBI for loan against jewellery is little different from that to the MFIs. While

loans to MFIs have been given PSL status, there is also a recommended cap on yields that

can be charged. While for loans against jewellery, there is no PSL status but also no cap on

yield to be charged. A cap on the yields to be charged or NIMs would have been more

detrimental than the costs going up by 144bps (adjusting for equity) which he can passeed

on. By removing the PSL status, RBI probably is guiding that they do not want to regulate

loan against jewellery the same way as microfinance loans.

Earnings may not dilute but return ratios will

While we have not changed our earnings assumptions for MAGFIL, we have built in now

additional dilution of 15% in our FY12 equity to take into account the higher capital

adequacy requirements. We have built in a total capital raising of Rs8bn in FY12 to jack up

the tier I CAR to ~25%.

Our growth assumptions lower than guidance

Our assumptions of AUMs in FY12 at Rs120bn are lower than the management guidance of

Rs150bn. We believe that building Rs150bn of AUMs would be a daunting task looking at

the fact that MAGFIL is planning to take its branch network to ~2500 by the year end.

We have tried to analyse MAGFIL’s growth scenario under three situations, viz., stable gold

prices, 20% appreciation in gold prices and 20% depreciation in gold prices.

Assuming stable gold prices, to achieve a target of Rs150bn by FY12, MAGFIL would have

to have 2.1mn customers and will have to service ~9.5 customers per day per branch which

is ~20% higher than current rate. Assuming the gold prices go up that number would still be

~7.7, in line with last eight quarters average. If the gold prices go down by 20% then the

number of customers to be serviced per day per branch would go up to ~12, 40% higher

than current run rate. In our calculations we have assumed higher number of branches of

3000 compared with 2500 guided by the management.

Valuation and view

While we are keeping our estimates for MAGFIL unchanged for FY11 and FY12, we believe

that the RoEs of the company are likely to tread in the range of 21-22% due to requirement

of raising capital and meeting CAR. We are downgrading our TP on the stock to Rs120

(valuing at 1.8x P/ABV instead of 2.5x earlier). However, with due to sharp price correction,

we upgrade our rating to BUY from HOLD with TP of Rs120

The downside risks to our call will be (1) inability to raise capital in which case there will be

~16% risk to our AUMs assumptions as well as earnings and (2) sharp drop in gold prices

which would affect the growth as well as recoveries.