Post the regulator cracking whip on the gold loan business, concerns have emerged about the survival of the business model given –
· The cap on LTVs – By targeting the main raison d'être for the booming business, the demand would be curbed to a great extent
· Deepening competition: Banks can swamp over the NBFCs
· Rickety lending yield: Ready to crack, taking a toll on margins
With these concerns clogging our mind, we decided to hit the road and visit branches and customers across multiple asset financiers across the nation to ascertain ourselves if it was the end of the game for gold loan NBFCs or if they could still survive the grueling times. The mission was undertaken mainly to gauge the competitive landscape, demand dynamics including the end-use of products, underwriting standards, risk management and security process besides the impact of recent regulatory changes on product profile, customer behavior, etc.
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What we saw: Despite near term challenges, business model is here to stay
Our stopover at 150 plus branches across South, West and North of India attests the fact that the business model of gold loan NBFCs is here to stay for good notwithstanding the following lingering concerns:
· LTV: Limited impact due to a shift in collateral valuation to replacement cost (including making charges) vis-à-vis the gold content based valuation.
· Demand is genuine as gold loans being the fastest and the most convenient form of financing short term personal/business needs
· Lending yield: Pricing power is highly evident from the steadily sustained lending yield. In fact, we were surprised to find that some financers had even affected a hike. This reaffirms our belief that interest rate is less important a factor for decision making.
· Competition: Despite their twin advantages of higher LTV and lower interest rate offerings, banks will have to work hard to tackle the aggression of existing players and changing customer perception (high TAT, documentation, etc) to make a larger dent in the business.
How should investors view this space?
We accept that FY13 will be the year of consolidation for gold finance companies in term of growth and margins though stability at the ground level might surprise the consensus numbers and expectation. From FY14 onwards, the business model would deliver steady state of 15-20% growth, impressive return profile (ROA of 3.5-4.0% and ROE of 20-25%) and benign asset quality metrics, a key investor pull. We prefer to play this space via quality players like Muthoot Finance (initiating with BUY/Sector Outperformer and TP of INR185, valuing it at 1.5x FY14E book) or major beneficiaries of regulatory changes like Federal Bank. We also upgrade Manappuram Finance to BUY/Sector Outperformer with TP of INR41 (1x FY14E book).
Regards,
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