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Manappuram
‘Gold’en opportunity; a new Buy with PO of Rs175
„Initiate with a Buy; 38% upside potential to PO of Rs175
Manappuram General Finance & Leasing (MGFL) is India's 2nd largest non-bank
gold finance firm with 7% share in organized gold loan market. We expect stock to
re-rate to ~3.2x FY12E book (vs ~2.8x FY11E book) led by 1) EPS CAGR of
+55% over FY10-13E; 2) market share gain within organized segment driven by
distribution expansion and proven expertise; 3) healthy asset quality with net
NPLs <0.2% owing to strong risk controls and sentimental value of collateral for
borrower and; 4) superior expected returns of 4.9% RoA and +22% RoE. Our
price objective implies P/E of 15.5x FY12E EPS, inline with markets, but with
higher earnings trajectory.
Untapped demand = huge growth potential for MGFL
Gold loan financing is an under–penetrated, fragmented market – India holds
about 10% of the world’s gold stock (by value), but loans are only ~1.2% of the
gold held. The organized gold loan market is expected to grow at 30-35% yoy
over the next few years and MGFL should benefit the most given its rapidly
increasing scale, expertise, brand equity and niche servicing.
EPS growth expected at +70/65% in FY11E/12E, top-line driven
We estimate net profit growth at +115% in FY11 and +80% in FY12, but see lower
EPS growth – 70% in FY11E, 65% in FY12E – due to the recent dilution. Earnings
growth to be driven by AUM growth of +45% CAGR in FY11E-13E and high
margins (11-12%). We are factoring in credit costs of +40-45bp in FY12E/13E.
Key risks are higher competition leading to lower growth and risks of theft and
frauds.
MGFL our new Buy: PO of Rs175
MGFL is the second-largest non-banking finance company (NBFC) in India. It is a
specialized player in the domestic organized gold market with a 7% share. We
initiate with a Buy rating and a price objective of Rs175 (38% upside potential).
Hence, we believe the stock, which is trading at ~2.8x FY11E book, can re-rate to
~3.2x FY12E book, which gives us our PO of Rs175. Our PO implies a target P/E
of ~15.5x, but with earnings CAGR of more than +55% through FY10-13E.
Why we are bullish
„ Earnings CAGR of +55% through FY10-13E driven by topline growth.
„ MGFL is among the best positioned to benefit from the market growth –
estimated 30-35% YoY.
„ Gold loan financing is an under–penetrated, fragmented market – India holds
about 10% of world’s gold stock (by value), but loans are ~1.2% of gold held.
„ Asset quality in this segment is manageable – the default rate on gold loans
is relatively low (NPLs below 0.2-0.3%) due to cultural aspects/strong
sentimental value attached to pledged jewelry in India, the physical custody
of the asset with the lender, and strong risk management systems in place.
„ The stock’s risk-return is positive, in our view. Strong earnings growth should
result in superior return ratios – RoA estimate of +4.9% and RoE estimate of
+22-23% – during FY12.
We detail out our bullish thesis below:
Untapped demand for gold loan finance in India
The growth potential for gold loan financing is huge in India – the organized gold
loan market is only about 1.2% of the gold stock held in India. To put that in
perspective, we highlight that India holds 10% of the world’s gold stock, by value.
We see India’s gold loan finance market growing at 30-35% YoY owing to –
„ A significant shift in gold loan financing from unorganized lenders (75% of the
market) to organized players, fuelling growth in that segment. Local money
lenders charge very high interest rates – more than 36% p.a. – which should
drive customers to organized players like MGFL. Rapidly increased
distribution (+3x in last 2-3 years to +1950 now) and brand awareness should
allow MGFL to increase its AUM faster than competition.
„ Further, growth could be even higher as customer attitude towards gold
pledging becomes more positive due to changing psychographics (debtaverse psychology aided by aggressive promotion by operators). There is a
strong view that the gold loan market can be expanded beyond South, if one
were to launch a targeted promotion and consumer education campaign.
MGFL: To capitalize on distribution ramp-up
In our view, distribution is the key enabler for growth as it allows MGFL to rapidly
expand its customer base. MGFL has rapidly scaled up its distribution network to
grab market share. Its network has increased six-fold from 291 branches in March
2007 to 1,900 now. That apart, it also undertook an aggressive marketing
campaign in the past 18 months to raise awareness on gold loans and improve
recognition of the MGFL brand.
Strong risk control + sentimental customers = Low defaults
The default rate on gold loans in India is relatively low (NPLs below 0.2-0.3%)
due to cultural aspects/strong sentimental value attached to pledged jewelry, and
the physical custody of the asset with the company. With an average LTV of 75%
(excluding making charges etc, which makes up 15-20% of the cost of gold
jewelry), the risk of default is low for MGFL, in our view.
Recent RBI directive not to hurt growth, but margins hit
On 3 Feb, the RBI notified that loans sanctioned to NBFCs for lending to
individuals/entities against gold jewelry may not be classified under the
“agricultural sector”. The securitization/assignments of gold loan portfolios of
NBFCs are also not eligible under this classification, hence forth. Prior to this
directive, loan given by banks to gold finance companies and assignments by
gold finance companies were eligible for priority sector tag and hence lowered
their funding costs.
We don’t forecast a sharp reduction in access to funding, but the RBI directive
could increase funding costs by at least +100-150bps for MGFL. We estimate its
NIM will decline by ~200bp during FY11-13 and MGFL’s ability to leverage may
decline on this directive and as loans on its balance sheet rises. But better
operational efficiency (Opex to avg. assets to decline by 150bp by FY13E) should
mitigate the impact on RoA, in our view.
EPS growth of 70% in FY11E, 65% in FY12E, 35% in FY13E
Despite the recent RBI regulation, we estimate MGFL’s profit will rise +115% in
FY11 followed by +80% in FY12 and 35% in FY13. However, we see EPS growth
lower at 70% in FY11E and 65% in FY12E, given the recent dilution. Earnings
growth is likely to be driven by the following:
„ AUM CAGR estimate of +45% through FY11-13 thanks to rapid increase in
distribution network and an under-penetrated gold loan financing market.
„ High margins of +11-12%, despite an estimated ~200bp decline through
FY13, owing to the recent RBI circular and rising rates.
„ We are estimating credit costs of 40-45bp through FY12/13. But asset quality
should remain manageable – estimating gross NPLs <0.8%, net NPLs about
0.2% through FY13 – owing to lower defaults, thanks to strong risk control
and customer behavior (sentimental value attached to collateral in India).
Can trade at theoretical multiples
We have traditionally valued banks/NBFCs on P/BV-ROE, as we believe this best
captures the risk-return trade-off. This relationship, however, is usually not linear
as the ROE expands beyond cost of equity. Typically, a company is likely to get a
premium over its P/BV multiple as it generates a higher ROE, or is relatively
better positioned than peers to capitalize on the growth opportunities. We have
valued MGFL using the growth-adjusted P/BV method with the following key
assumptions:
„ ROE: Average 23% (FY11-13E) owing to dilution (avg. RoE at over 35%
during FY05-10);
„ Cost of equity at 14%.
„ Sustainable growth rate of 10%, given MGFL’s ability to gain market share.
We believe stock trading at 2.8x FY11E book will rerate to ~3.2x FY12E book (at
Gordon multiples), as MGFL’s growth potential is strong, despite rising
competition, given recent ramp-up in scale, expertise and brand equity.
We believe P/E may gain more relevance for companies like MGFL with very high
earnings growth (+55% CAGR estimate through FY10-13) and offering high
comfort on asset quality. Hence, we peg our target price objective at a PE of
~15.5x FY12E earnings, which is in-line with market multiples, but with higher
earnings growth trajectory.
Risks
Rising competition; Risk of fraud and theft
Loans against gold have recently been in the limelight and captured the interest
of a new set of players – like Shriram City Union, Reliance Capital and M&M
Financial have also recently entered this segment. Competition is bound to
continue rising in the next few years. MGFL needs to invest in the physical safety
of gold at its branches and would need to scale-up in building vaults to guard
against the risk of fraud and theft.
In light of RBI's recent actions, while the cost of capital will go up access to capital
also could be challenging as banks may no longer find it attractive to lend to gold
finance companies.
MGFL's inability to scale up in a timely manner its risk management systems in
line with expanding business could potentially lead to asset quality issues.
Gold finance market in India
Gold-backed lending has recently captured the interest of a new set of players,
namely NBFCs like Shriram City Union and M&M Financial have recently entered
this segment. The organized market itself is only ~25% of the total market in India
as unorganized players control almost 75% of the market. However, given certain
favorable dynamics like increasing penetration of organized players and brand
awareness campaigns, the growth in organized gold loan finance market is
expected to continue to grow at +30-35% for the next few years.
Table 1 broadly classifies the market share of various NBFCs and banks as on
FY10. This market share is on 25% overall market share that organized segment
currently controls and does not have the unorganized segment (money lenders
and pawnbrokers) that control ~75% of the market taken in to account.
Untapped market = Huge growth potential
India is one of the largest markets for gold with accumulated gold stock estimated
at ~15-20k tonnes, translating into ~10% of the global gold stock. Gold is viewed
as a savings/investment instrument and as a cultural/sentimental symbol of
wealth and prosperity. Based on data published by the World Gold Council and
RBI, the value of gold in private hands is estimated at ~60% of the total bank
deposits. We believe the growth in this ‘organized’ market is likely to sustain at
+30-35% yoy for next 3-4 years owing to
„ Under penetration: Players like MGFL have great growth potential,
considering the current estimated size of the organized gold loans market in
India, which is equal to ~1.2% of the value of total gold stock which signifies
to us a hugely underpenetrated market. Rural India is estimated to hold
~65% of the gold stock. Southern India is the largest market accounting for
40% of India’s gold demand, followed by West at ~25%, North at 20-25% and
East at 10-15% of annual Gold demand.
„ Shift from unorganized to organized players: A shift of significant part of
the gold loans, likely from the unorganized lenders to organized ones,
fuelling growth in the organized market. In India, there is a large, longoperated, unorganized gold loans market (~75% of market) marked by the
presence of pawnbrokers, money lenders and cooperative societies. Being
largely unregulated, customers are vulnerable to being exploited with
exorbitantly high interest rates.
„ Changing psychology of borrowers: Growth could be even higher if
customers’ attitude towards gold pledging becomes more positive due to the
changing psychographics (‘debt-averse psychology’) in favor of asset
creation through growth in financial liabilities, aided by aggressive promotion
by operators. Further, we believe with aggressive branding by organized
players will tune customer psychology from money lenders who charge
exorbitant rates of +36% p.a. to organized players like MGFL who charge
+25-26% average rates for same loans.
„ Expansion of market beyond South India: Today bulk of the organized
players are concentrated in Southern India as the stock of gold holdings is
high and borrowers of this region are well tuned towards borrowing towards
gold jewelry. Per industry estimates, Southern region holds highest per
capital stock of gold at 17gms, followed by North at 6.2gms, East at 6.0gms
and West at 4.5gms. Hence there is a strong view that the gold loan market
can be expanded beyond South. A targeted promotion and consumer
education campaign could allow MGFL to continue to grow its loan book at
very strong growth rate.
NBFCs: Competitive advantage vs. Banks
Due to a more customer-focused approach, easier access to loans and rapid
expansion of branch distribution, NBFCs like MGFL specializing in gold loans
have grown much faster than banks. As per industry estimates, the market share
of NBFCs in the gold loan market has grown from 18.4% in FY07 to 32.2% in
FY10.
Focused player: NBFCs enjoys a big advantage vis-à-vis banks as they are
dedicated gold loan financiers vs. banks for whom gold loan financing is just a
small vertical. Further, gold loan financing is a challenge for banks, given the high
operational costs involved.
Fast processing: NBFCs process gold loan requests within 15 minutes, with
minimal formalities, while banks could take up to one full day.
Interest charged only until the date of repayments: Banks usually charge 15
days of extra interest irrespective of repayment date, while NBFCs usually charge
only until the date of repayment, giving it a competitive advantage.
Higher LTV vs. banks: NBFCs also have an advantage over banks as in they
offer an LTV of 75% vs. banks at 65% average. Further, to remain competitive
with banks on rates, NBFCs also offer LTV of 65% at 11-12% interest rates vs.
their usual 24% rate at higher LTV, with the loan amount capped at Rs10,000.
MGFL – In a ‘sweet spot’
MGFL is a leading NBFC providing loan against gold, with AUM of Rs65bn
US$1.4bn) and an estimated ~7% share of the organized market. Its average
ticket size is estimated at Rs63,704 (~US$1,380) as on Dec’10, with ~75% of
loans in the states of Karnataka, Kerala, Tamil Nadu, and Andhra Pradesh.
Poised to capitalize on market growth
Last mile access: MGFL provides quick liquidity to households (particularly in
the rural and semi-urban areas) to meet their urgent personal (marriage,
education, medical, etc) or business (working capital) needs or cash flow
mismatches. The end use of the funds is more recurring in nature rather than
typical consumer loans for various one-time usages. These households are not
adequately served by banks due to lack of documentation, credit history, limited
local market knowledge and low ticket size with high operating costs. MGFL,
however, does not provide loans to jewelers, banks, or against commodity bullion.
Rapidly increasing distribution, key to future growth: MGFL’s efforts over the
last three years are dedicated at capturing a leadership position, achieving scale
and visibility and strengthening brand image to compete effectively in an underpenetrated market. MGFL has, over the past three years, aggressively ramped up
its distribution network to have the first-mover advantage in leveraging on
opportunities. MGFL has expanded its network from 291 branches in FY07 to
+1950 in Feb’10. MGFL’s business is largely concentrated in the South (Kerala,
Tamil Nadu, Andhra Pradesh and, Karnataka), which currently accounts for ~75%
of its network.
Strong risk management / assessment systems in place: MGFL runs a
thorough and detailed process of verification/assessment, but the turnaround time
for the customer is very effective (less than 15 minutes). Despite the short
turnaround time, there are several stringent systems, product and process level
controls to manage asset quality. As a strategy to minimize default levels, the
company has introduced many system level controls, wherein loans are not
provided: 1) to jewelers; 2) against gold, bullion and storable forms. The company
also follows a strong hierarchy at branches and regions to ensure alignment of
authority and financial responsibility.
Target customer focus makes MGFL preferred lender vs. banks: Besides
capitalizing on the advantages enumerated above that NBFCs like MGFL enjoy
vs. competition (banks, etc), MGFL, per se, focuses on professions and people
with irregular income streams and on short-term fund requirements of farmers,
agriculturists, small vendors and middle- to low-income groups.
Aggressive branding campaign nation-wide also increasing awareness:
Apart from its rapid branch expansion, MGFL has undertaken an aggressive
marketing campaign in the past 18 months to raise awareness on gold loans and
improve recognition of the MGFL brand. Hence, total advertisement expenses
have increased from Rs119mn in FY09 to Rs483mn in FY10 and Rs825mn in
9MFY11. The increase in brand awareness and aggressive branch rollout will
lead to rise in average ticket size, which will support AUM growth here on.
Recent regulatory issues overdone
NBFCs like MGFL enjoyed benefits (lower) on funding costs owing to gold loans
being eligible earlier as priority sector for banks. However, recently RBI (3
rd
Feb’2011) notified that loans sanctioned to NBFCs for on-lending to individuals or
other entities against gold jewelry are not eligible for classification under the
agricultural sector and securitization/assignments of gold loan portfolios of
NBFCs also do not stand eligible under this classification. The notification is silent
on priority sector status for micro-credit (loans of amount not exceeding Rs
50,000 per borrower) originated by banks either directly or indirectly through a
SHG/JLG mechanism or to NBFC/MFI.
Our views on this issue
Growth impact limited: Growth (volumes) momentum to remain largely
unaffected. The inherent favorable dynamics like under-penetration, 3/4
th
share of
the gold finance market with money lenders, changing psychology of the
borrowers, coupled with MGFL’s efforts over the past three years dedicated at
achieving scale and visibility and strengthening brand image will likely drive
growth here on. ~60% of the branches have been added over the past 15-18
months. We believe that growth may sustain and banks will continue to fund
MGFL owing to its strong capital position, good track record of managing asset
quality and profitability. But the funding costs may rise (discussed below).
Funding costs to rise but to be partly offset by operating leverage: While the
recent RBI guidelines will impact the availability of funding to some extent, we do
not see funding drying up for MGFL, as at 3QFY11 ~45% of its debt funding was
from the non-priority sector route (bank credit lines, CPs, NCDs). Even within the
priority sector, only 35% was from sell-down to banks (a source of concern), while
the remaining 65% were credit lines from banks at slightly lower rates due to the
priority sector tag. Since the cost of funds which came through the priority sector
were ~150-200bp cheaper than normal bank borrowings, removal of priority
sector status would increase the cost of funds for gold NBFCs. While on the back
of this, we factor in NIM compressing by ~200bp in FY11-13, but increased
operational efficiency (opex to avg. assets declining by ~150bp by FY13) should
mitigate the impact on RoA.
Leverage to come off; capital consumption to increase: Gold financing
companies like MGFL were selling ~20-25% of their loan portfolio to banks for
which they were not required to set aside equity capital. Now NBFCs will not be
able to sell their portfolio to banks and will have to keep this portfolio on their
books. Hence the NBFCs will have to set aside the mandatory regulatory capital
of 15% for loans. This means that NBFCs’ ability to leverage would go down. But,
on the contrary it would be cushioned for MGFL, as they have recently raised
capital and have high CAR (Tier 1 of +32%).
Earnings CAGR of +55% during FY10-13E
Despite the recent regulatory issues, as discussed above, we still estimate
MGFL’s profit will grow +115% in FY11 followed by +80% in FY12 and 35% in
FY13. But earnings (EPS) growth is likely to be lower at +70% in FY11E and
+65% in FY12E on recent dilution. Earnings growth to be driven by -
AUM: +85% CAGR in FY08-10; +45% CAGR over FY11E-13E
Gold loan AUM for MGFL has clocked a +85% CAGR over FY08-FY10. Robust
loan growth over this period was also supported by higher gold prices. In
9MFY11, growth remained robust with total AUM rising +150%, despite only
+25% increase in gold prices, signaling strong underlying demand.
We estimate gold loan AUM will cross Rs160bn by FY13 (+45% CAGR over
FY11E-13E). We believe that new branch additions and higher productivity from
branches opened in the past few years would support AUM growth (~60% of its
current branch network added in the past 12 months, where productivity is
significantly lower than that at its established centers).
Not factoring in securitization from FY12 and beyond
We are also not building in any securitization / assignments from FY12E as the
recent RBI circular mandating companies to preserve loans on their b/s for at
least 12 months will play spoilsport if implemented, given MGFL’s average
duration of a loan is only 3-4 months.
Margins high at 11-12%, post correction on RBI directive
MGFL has enjoyed margins in excess of 14-15% as: a) MGFL enjoys high
lending yields at +21-27% (60% of loans) due to shorter maturity of loans and
higher churning of the portfolio, yields turn out to be relatively higher than average
contracted rates and b) it got the benefit of lower funding costs until recently due
to its loans classified as priority sector loans for bank’s priority sector
requirements.
Going ahead, the benefit of lower funding costs will abate due to RBI directive, as
discussed earlier, and also as borrowing rates rise, but we still expect margins to
remain in +11-12% range owing to high loan yields and MGFL deriving benefit of
leverage of QIP float money that it recently raised.
Benefits of operating leverage to kick-in, going ahead
Rapid growth in business and branch distribution and marketing campaign has
led to relatively high cost income ratios for MGFL over the past few years. Also,
given the nature of the business, high staff numbers along with ongoing training is
required, which leads to higher expenses.
MGFL’s operating expenses are primarily fixed in nature. Consequently, with
increasing scale, we believe the cost-to-income (C/I) ratio would decline going
forward, boosting profitability. However, we estimate this would happen only postFY11, when growth in advertising expenses taper down. These expenses
(+Rs1.2bn in FY11E as against Rs0.5bn in FY10) would see the C/I ratio
increasing from ~43% in FY10 to ~48% in FY11E. Thereafter, we expect a
decline to ~40-41% by FY13E. Operating expenses are projected to increase at
~65% CAGR through FY10-13E
Asset quality: healthy
Default rate on gold loans is relatively lower (NPLs less than +0.2-0.3%) due to
cultural legacy/strong sentimental value attached to the pledged jewelry and
physical custody of the asset with the company. With an average LTV of 75%,
risk of default to MGFL is low. Historically, NPLs were high owing to MGFL’s
hypothecation commercial loan portfolio, where gross NPA rose rapidly in FY08
and FY09. However, MGFL has exited that business completely and the
proportion of CV loans has declined from 18% in FY06 to only 1% in FY10.
We expect gross NPA to decline to 0.7% by FY12E from ~1.2% in FY10. We
also note that ~75% of the company’s total outstanding loans have an LTV of less
than 75%. We are factoring in credit costs of 61bp in FY11E and +40-45bps each
in FY12E and FY13E. The higher credit costs in FY11 builds in incremental
provisions of 25bps on standard assets.
Risk management systems tuned to prevent defaults
MGFL starts with Know Your Customer (KYC) norms, where customers are
required to provide only a valid identity proof. There are several stringent
systems, product and process level controls to manage the asset quality. As a
strategy to control default levels, the company has introduced few system-level
controls, wherein loans are not provided: 1) to jewelers; 2) against gold, bullion
and storable forms. The company also follows strong hierarchy at branches and
regions to ensure alignment of authority and financial responsibility.
MGFL carries out several different checks to determine the quality and value of
collateral against which lending is done, each test duplicated at various levels.
Despite a thorough and detailed process of verification/assessment, the
turnaround time is very effective (less than 15 minutes). This is possible due to
training provided and expertise developed to/by the operational staff involved and
the technology platform. MGFL has tried to capture the business intelligence and
risk management process developed over years of lending (pertaining to
methodology of verification, weight/purity adjustments, computation of LTV and
loan amount) onto a common IT platform developed in-house.
Strong physical security
Post verification, every ornament is stored in a safety vault located in each
branch. Vaults have RCC structures on six sides (1.5 ft thick) and keys are
handled by the Branch Head (BH) and Assistant Branch Head (ABH) under dual
custody. Vaults are linked to servers and any break-ins send emergency
message to key management personnel from the Chairman to BH. For inventory
control, daily reports and monthly reports are regularly sent to the HO based on
mandatory checks. Moreover, regional managers and internal auditors verify gold
on a consistent basis and flying squads conduct surprise checks at branches.
Gold price correlation with asset quality
While insulation from a sharp correction in gold prices in few months is low, we
believe there are few controls which can prevent lenders like MGFL from high
defaults. These are enumerated below:
„ MGFL normally provides loans against household-used jewelry and not
against gold bars. They calculate the LTV on the scrap value of the gold.
This improves the margin of safety for MGFL in the event of a fall in gold
prices, as the value of the jewelry is normally ~15-20% higher than the scrap
value of the gold, as it includes the making charges of the jewelry. Hence,
the replacement cost of the jewelry for the borrower is much higher than the
scrap value and this makes willful default less likely, even if there is a
correction in gold price. Hence, effective LTV is only <70-75%.
„ The average duration of the jewelry loans is ~100 days and ~65% of the
loans are repaid within 90 days and 85% within 180 days. Only 15% of the
loans go beyond 180 days. Hence the sector is insulated to a significant
extent from a gradual decrease in gold prices.
„ Some lesser known features of gold financing contracts mitigate to a great
extent the NPA risk in the event of a sharp decline in gold prices: 1) MGFL
has the right to make a margin call if the LTV falls below their comfort level
and; 2) MGFL has the right to sell the pledged gold even before the
completion of loan tenure in case the LTV crosses 90%.
Well–capitalized for the next phase of growth
Recent RBI directive (as discussed above) will result in lower securitization and in
effect higher on B/s loans. But MGFL is well positioned post recent QIP, with Tier
1 of +32% to absorb the higher capital consumption.
DuPont Analysis
We estimate RoAs to sustain at 4.4% and RoEs to expand to +24-25% by FY13
from ~20% in FY11E, but lower than FY10 owing to recent RBI directive, which
will increase MGFL’s funding costs and compress topline (margins). Also,
improving operating efficiency, as pace of branch and staff expansion normalizes,
will also compensate for lower topline and hence RoAs likely to sustain at +4.4%.
There could be further upside to RoAs and RoEs in FY13E from our current
estimate as we build in loan growth of only ~30% in FY13E.
Valuation: Favorable risk-return
MGFL has no listed comparables domestically, but globally we have a few listed
players who are basically into similar business of lending against gold. They are
H&T Group, Inc and Cash America International. Both foreign players are trading
at 1.2-1.6x CY11E book but also have RoEs of only 14-16%.
Valuing MGFL at ~3.2x FY12E adj. book
We initiate coverage on MGFL with a Buy rating. We believe the stock can re-rate
to ~3.2x FY12E book (trades at ~2.8x FY11E book), which is at theoretical
multiples (see assumptions below), as growth potential for MGFL is strong,
considering significantly untapped organized gold loan market in India (~1.2% of
gold stock value) and MGFL’s ability to grow way above average, given its scale,
expertise and brand equity.
Valuing the company on growth-adjusted P/BV method
The P/BV-ROE relationship does not capture the underlying growth potential of
the NBFCs, especially for those whose growth is likely to exceed the “normalized”
growth rate of 6-7% expected in a fast-growing economy like India where real
GDP growth is forecast at +7-8% through FY12 and possibly beyond.
The standard equation below is an example of how growth could be captured and
how the P/BV multiple tends to expand exponentially as growth climbs upwards.
In the equation, “g” stands for the compound annual growth rate:
Fair Value (P/Adj. BV) = (ROAE – g) / (Cost of Capital – g)
We have valued MGFL using the growth-adjusted P/BV method (above equation),
with the following key assumptions:
„ ROE: average 23% (FY11E-13E) owing to dilution; average RoEs at over
35% in FY05-10
„ Cost of equity at 14%
„ Sustainable growth rate of 10%, given MGFL’s ability to gain market share.
Based on the above equation, we believe that MGFL can sustain multiples
in excess of +3.2-3.3x one-year forward, given its ability to grow way above
average, given its scale, expertise and brand equity.
Markets may pay high multiples for high consistent growth/ROEs
We have traditionally valued banks/NBFCs based on P/BV-ROE as we believe
this best captures the risk-return trade-off. The ROE-P/BV relationship, however,
is unlikely to be linear as the ROEs expand beyond the CoEs. Typically, a
company is likely to get a premium over its P/BV multiple as it generates higher
ROE or is relatively better positioned to capitalize on growth opportunities in
India.
If a company like MGFL can generate a stronger ROE compared with its cost of
capital, the growth becomes higher and the multiple expands. The high growth
that is accompanied by a high ROE is valued by the market.
In emerging markets, banks / NBFCs that can provide higher ROEs, with sound
asset quality and strong growth potential, tend to trade at significantly higher
multiples, as is the case with private banks in India. Hence, we believe the
relationship between P/BV and ROE tends to be more exponential as ROEs
expand beyond CoEs.
P/E to gain relevance for high growth & manageable asset quality Co’s
We believe P/E may gain more relevance for companies like MGFL with very high
earnings growth (+55% estimated CAGR through FY10-13) and offering high
comfort on asset quality. Hence, we peg our target price objective at a PE of
~15.5x FY12E earnings, which is in-line with market multiples, but earnings
growth much higher than market earnings growth.
Company description
Manappuram Group was started in 1949 by Late Mr. V. C. Padmanabhan, with
focus mainly on money lending activities. Manappuram General Finance, the
flagship company of Manappuram Group, is the leading gold-loan providing
NBFC based out of Kerala. Mr. V.P. Nandakumar, the present chairman, took
over the reins from his late father in 1986 after his illustrious stint with Nedungadi
Bank. The group has come a long way in 60 years, operating five companies
under its fold, spread over 18+ states with more than 1,950 branches, a total
business of over Rs65bn (AUM) and an employee base of over 14,670, and a live
customer base of over 1mn.
Management
Mr. V.P. Nandakumar is the chairman and Mr. I. Unnikrishnan is the managing
director of the company.
Mr. V.P. Nandakumar (Executive Chairman) is the promoter of the
Manappuram Group of Companies. He holds a masters degree in science from
Calicut University and is also a Certified Associate of Indian Institute of Bankers.
Mr. Nandakumar has been associated with the banking industry in various
capacities. He is the Chairman of the Equipment Leasing Association (India) and
the Kerala Non-Banking Finance Companies Welfare Association.
Mr. I. Unnikrishnan (Managing Director) holds a bachelors degree in
commerce from Calicut University and is a fellow member of the Institute of
Chartered Accountants of India. He has experience in rendering advisory services
relating to NBFCs. He has in the past worked with HAWA-MK Electrical Limited.
He has been the Director of Manappuram since October 11, 2001.
Price objective basis & risk
Manappuram (XCHWP)
MGFL is the second largest NBFC with market share of 7% in organized
segment. We believe stock can re-rate to +3.2-3.3x FY12E book, as 1) we
estimate earnings growth of +55% through FY10-13, 2) MGFL capitalizes on
US$11bn market opportunity growing at +30-35% yoy, with MGFL better
positioned driven by rapidly rising distribution and proven expertise and, 3) asset
quality remains manageable (net NPLs at <0.2%) driven by strong risk
management systems and sentimental value of collateral. Hence, we estimate
above average RoAs (+4.4%) and RoEs (+22-25%) to sustain. Hence, we believe
the stock trading can rerate to +3.2x FY12E book multiples (at Gordon theory
multiples assuming RoE of 23%, CoE at 14% and sustainable growth of 10%), as
growth potential for MGFL is strong. Our Rs 175 price objective implies P/E of
15.5x FY12E EPS, in-line with markets, but with higher earnings trajectory. Key
risks are rise in thefts and frauds and increase in compeitition, which can hurt
growth. In light of RBI's recent actions, while the cost of capital will go up access
to capital also could be challenging as banks may no longer find it attractive to
lend to gold finance companies. MGFL's inability to scale up in a timely manner
its risk management systems in line with expanding business could potentially
lead to asset quality issues.
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Manappuram
‘Gold’en opportunity; a new Buy with PO of Rs175
„Initiate with a Buy; 38% upside potential to PO of Rs175
Manappuram General Finance & Leasing (MGFL) is India's 2nd largest non-bank
gold finance firm with 7% share in organized gold loan market. We expect stock to
re-rate to ~3.2x FY12E book (vs ~2.8x FY11E book) led by 1) EPS CAGR of
+55% over FY10-13E; 2) market share gain within organized segment driven by
distribution expansion and proven expertise; 3) healthy asset quality with net
NPLs <0.2% owing to strong risk controls and sentimental value of collateral for
borrower and; 4) superior expected returns of 4.9% RoA and +22% RoE. Our
price objective implies P/E of 15.5x FY12E EPS, inline with markets, but with
higher earnings trajectory.
Untapped demand = huge growth potential for MGFL
Gold loan financing is an under–penetrated, fragmented market – India holds
about 10% of the world’s gold stock (by value), but loans are only ~1.2% of the
gold held. The organized gold loan market is expected to grow at 30-35% yoy
over the next few years and MGFL should benefit the most given its rapidly
increasing scale, expertise, brand equity and niche servicing.
EPS growth expected at +70/65% in FY11E/12E, top-line driven
We estimate net profit growth at +115% in FY11 and +80% in FY12, but see lower
EPS growth – 70% in FY11E, 65% in FY12E – due to the recent dilution. Earnings
growth to be driven by AUM growth of +45% CAGR in FY11E-13E and high
margins (11-12%). We are factoring in credit costs of +40-45bp in FY12E/13E.
Key risks are higher competition leading to lower growth and risks of theft and
frauds.
MGFL our new Buy: PO of Rs175
MGFL is the second-largest non-banking finance company (NBFC) in India. It is a
specialized player in the domestic organized gold market with a 7% share. We
initiate with a Buy rating and a price objective of Rs175 (38% upside potential).
Hence, we believe the stock, which is trading at ~2.8x FY11E book, can re-rate to
~3.2x FY12E book, which gives us our PO of Rs175. Our PO implies a target P/E
of ~15.5x, but with earnings CAGR of more than +55% through FY10-13E.
Why we are bullish
„ Earnings CAGR of +55% through FY10-13E driven by topline growth.
„ MGFL is among the best positioned to benefit from the market growth –
estimated 30-35% YoY.
„ Gold loan financing is an under–penetrated, fragmented market – India holds
about 10% of world’s gold stock (by value), but loans are ~1.2% of gold held.
„ Asset quality in this segment is manageable – the default rate on gold loans
is relatively low (NPLs below 0.2-0.3%) due to cultural aspects/strong
sentimental value attached to pledged jewelry in India, the physical custody
of the asset with the lender, and strong risk management systems in place.
„ The stock’s risk-return is positive, in our view. Strong earnings growth should
result in superior return ratios – RoA estimate of +4.9% and RoE estimate of
+22-23% – during FY12.
We detail out our bullish thesis below:
Untapped demand for gold loan finance in India
The growth potential for gold loan financing is huge in India – the organized gold
loan market is only about 1.2% of the gold stock held in India. To put that in
perspective, we highlight that India holds 10% of the world’s gold stock, by value.
We see India’s gold loan finance market growing at 30-35% YoY owing to –
„ A significant shift in gold loan financing from unorganized lenders (75% of the
market) to organized players, fuelling growth in that segment. Local money
lenders charge very high interest rates – more than 36% p.a. – which should
drive customers to organized players like MGFL. Rapidly increased
distribution (+3x in last 2-3 years to +1950 now) and brand awareness should
allow MGFL to increase its AUM faster than competition.
„ Further, growth could be even higher as customer attitude towards gold
pledging becomes more positive due to changing psychographics (debtaverse psychology aided by aggressive promotion by operators). There is a
strong view that the gold loan market can be expanded beyond South, if one
were to launch a targeted promotion and consumer education campaign.
MGFL: To capitalize on distribution ramp-up
In our view, distribution is the key enabler for growth as it allows MGFL to rapidly
expand its customer base. MGFL has rapidly scaled up its distribution network to
grab market share. Its network has increased six-fold from 291 branches in March
2007 to 1,900 now. That apart, it also undertook an aggressive marketing
campaign in the past 18 months to raise awareness on gold loans and improve
recognition of the MGFL brand.
Strong risk control + sentimental customers = Low defaults
The default rate on gold loans in India is relatively low (NPLs below 0.2-0.3%)
due to cultural aspects/strong sentimental value attached to pledged jewelry, and
the physical custody of the asset with the company. With an average LTV of 75%
(excluding making charges etc, which makes up 15-20% of the cost of gold
jewelry), the risk of default is low for MGFL, in our view.
Recent RBI directive not to hurt growth, but margins hit
On 3 Feb, the RBI notified that loans sanctioned to NBFCs for lending to
individuals/entities against gold jewelry may not be classified under the
“agricultural sector”. The securitization/assignments of gold loan portfolios of
NBFCs are also not eligible under this classification, hence forth. Prior to this
directive, loan given by banks to gold finance companies and assignments by
gold finance companies were eligible for priority sector tag and hence lowered
their funding costs.
We don’t forecast a sharp reduction in access to funding, but the RBI directive
could increase funding costs by at least +100-150bps for MGFL. We estimate its
NIM will decline by ~200bp during FY11-13 and MGFL’s ability to leverage may
decline on this directive and as loans on its balance sheet rises. But better
operational efficiency (Opex to avg. assets to decline by 150bp by FY13E) should
mitigate the impact on RoA, in our view.
EPS growth of 70% in FY11E, 65% in FY12E, 35% in FY13E
Despite the recent RBI regulation, we estimate MGFL’s profit will rise +115% in
FY11 followed by +80% in FY12 and 35% in FY13. However, we see EPS growth
lower at 70% in FY11E and 65% in FY12E, given the recent dilution. Earnings
growth is likely to be driven by the following:
„ AUM CAGR estimate of +45% through FY11-13 thanks to rapid increase in
distribution network and an under-penetrated gold loan financing market.
„ High margins of +11-12%, despite an estimated ~200bp decline through
FY13, owing to the recent RBI circular and rising rates.
„ We are estimating credit costs of 40-45bp through FY12/13. But asset quality
should remain manageable – estimating gross NPLs <0.8%, net NPLs about
0.2% through FY13 – owing to lower defaults, thanks to strong risk control
and customer behavior (sentimental value attached to collateral in India).
Can trade at theoretical multiples
We have traditionally valued banks/NBFCs on P/BV-ROE, as we believe this best
captures the risk-return trade-off. This relationship, however, is usually not linear
as the ROE expands beyond cost of equity. Typically, a company is likely to get a
premium over its P/BV multiple as it generates a higher ROE, or is relatively
better positioned than peers to capitalize on the growth opportunities. We have
valued MGFL using the growth-adjusted P/BV method with the following key
assumptions:
„ ROE: Average 23% (FY11-13E) owing to dilution (avg. RoE at over 35%
during FY05-10);
„ Cost of equity at 14%.
„ Sustainable growth rate of 10%, given MGFL’s ability to gain market share.
We believe stock trading at 2.8x FY11E book will rerate to ~3.2x FY12E book (at
Gordon multiples), as MGFL’s growth potential is strong, despite rising
competition, given recent ramp-up in scale, expertise and brand equity.
We believe P/E may gain more relevance for companies like MGFL with very high
earnings growth (+55% CAGR estimate through FY10-13) and offering high
comfort on asset quality. Hence, we peg our target price objective at a PE of
~15.5x FY12E earnings, which is in-line with market multiples, but with higher
earnings growth trajectory.
Risks
Rising competition; Risk of fraud and theft
Loans against gold have recently been in the limelight and captured the interest
of a new set of players – like Shriram City Union, Reliance Capital and M&M
Financial have also recently entered this segment. Competition is bound to
continue rising in the next few years. MGFL needs to invest in the physical safety
of gold at its branches and would need to scale-up in building vaults to guard
against the risk of fraud and theft.
In light of RBI's recent actions, while the cost of capital will go up access to capital
also could be challenging as banks may no longer find it attractive to lend to gold
finance companies.
MGFL's inability to scale up in a timely manner its risk management systems in
line with expanding business could potentially lead to asset quality issues.
Gold finance market in India
Gold-backed lending has recently captured the interest of a new set of players,
namely NBFCs like Shriram City Union and M&M Financial have recently entered
this segment. The organized market itself is only ~25% of the total market in India
as unorganized players control almost 75% of the market. However, given certain
favorable dynamics like increasing penetration of organized players and brand
awareness campaigns, the growth in organized gold loan finance market is
expected to continue to grow at +30-35% for the next few years.
Table 1 broadly classifies the market share of various NBFCs and banks as on
FY10. This market share is on 25% overall market share that organized segment
currently controls and does not have the unorganized segment (money lenders
and pawnbrokers) that control ~75% of the market taken in to account.
Untapped market = Huge growth potential
India is one of the largest markets for gold with accumulated gold stock estimated
at ~15-20k tonnes, translating into ~10% of the global gold stock. Gold is viewed
as a savings/investment instrument and as a cultural/sentimental symbol of
wealth and prosperity. Based on data published by the World Gold Council and
RBI, the value of gold in private hands is estimated at ~60% of the total bank
deposits. We believe the growth in this ‘organized’ market is likely to sustain at
+30-35% yoy for next 3-4 years owing to
„ Under penetration: Players like MGFL have great growth potential,
considering the current estimated size of the organized gold loans market in
India, which is equal to ~1.2% of the value of total gold stock which signifies
to us a hugely underpenetrated market. Rural India is estimated to hold
~65% of the gold stock. Southern India is the largest market accounting for
40% of India’s gold demand, followed by West at ~25%, North at 20-25% and
East at 10-15% of annual Gold demand.
„ Shift from unorganized to organized players: A shift of significant part of
the gold loans, likely from the unorganized lenders to organized ones,
fuelling growth in the organized market. In India, there is a large, longoperated, unorganized gold loans market (~75% of market) marked by the
presence of pawnbrokers, money lenders and cooperative societies. Being
largely unregulated, customers are vulnerable to being exploited with
exorbitantly high interest rates.
„ Changing psychology of borrowers: Growth could be even higher if
customers’ attitude towards gold pledging becomes more positive due to the
changing psychographics (‘debt-averse psychology’) in favor of asset
creation through growth in financial liabilities, aided by aggressive promotion
by operators. Further, we believe with aggressive branding by organized
players will tune customer psychology from money lenders who charge
exorbitant rates of +36% p.a. to organized players like MGFL who charge
+25-26% average rates for same loans.
„ Expansion of market beyond South India: Today bulk of the organized
players are concentrated in Southern India as the stock of gold holdings is
high and borrowers of this region are well tuned towards borrowing towards
gold jewelry. Per industry estimates, Southern region holds highest per
capital stock of gold at 17gms, followed by North at 6.2gms, East at 6.0gms
and West at 4.5gms. Hence there is a strong view that the gold loan market
can be expanded beyond South. A targeted promotion and consumer
education campaign could allow MGFL to continue to grow its loan book at
very strong growth rate.
NBFCs: Competitive advantage vs. Banks
Due to a more customer-focused approach, easier access to loans and rapid
expansion of branch distribution, NBFCs like MGFL specializing in gold loans
have grown much faster than banks. As per industry estimates, the market share
of NBFCs in the gold loan market has grown from 18.4% in FY07 to 32.2% in
FY10.
Focused player: NBFCs enjoys a big advantage vis-à-vis banks as they are
dedicated gold loan financiers vs. banks for whom gold loan financing is just a
small vertical. Further, gold loan financing is a challenge for banks, given the high
operational costs involved.
Fast processing: NBFCs process gold loan requests within 15 minutes, with
minimal formalities, while banks could take up to one full day.
Interest charged only until the date of repayments: Banks usually charge 15
days of extra interest irrespective of repayment date, while NBFCs usually charge
only until the date of repayment, giving it a competitive advantage.
Higher LTV vs. banks: NBFCs also have an advantage over banks as in they
offer an LTV of 75% vs. banks at 65% average. Further, to remain competitive
with banks on rates, NBFCs also offer LTV of 65% at 11-12% interest rates vs.
their usual 24% rate at higher LTV, with the loan amount capped at Rs10,000.
MGFL – In a ‘sweet spot’
MGFL is a leading NBFC providing loan against gold, with AUM of Rs65bn
US$1.4bn) and an estimated ~7% share of the organized market. Its average
ticket size is estimated at Rs63,704 (~US$1,380) as on Dec’10, with ~75% of
loans in the states of Karnataka, Kerala, Tamil Nadu, and Andhra Pradesh.
Poised to capitalize on market growth
Last mile access: MGFL provides quick liquidity to households (particularly in
the rural and semi-urban areas) to meet their urgent personal (marriage,
education, medical, etc) or business (working capital) needs or cash flow
mismatches. The end use of the funds is more recurring in nature rather than
typical consumer loans for various one-time usages. These households are not
adequately served by banks due to lack of documentation, credit history, limited
local market knowledge and low ticket size with high operating costs. MGFL,
however, does not provide loans to jewelers, banks, or against commodity bullion.
Rapidly increasing distribution, key to future growth: MGFL’s efforts over the
last three years are dedicated at capturing a leadership position, achieving scale
and visibility and strengthening brand image to compete effectively in an underpenetrated market. MGFL has, over the past three years, aggressively ramped up
its distribution network to have the first-mover advantage in leveraging on
opportunities. MGFL has expanded its network from 291 branches in FY07 to
+1950 in Feb’10. MGFL’s business is largely concentrated in the South (Kerala,
Tamil Nadu, Andhra Pradesh and, Karnataka), which currently accounts for ~75%
of its network.
Strong risk management / assessment systems in place: MGFL runs a
thorough and detailed process of verification/assessment, but the turnaround time
for the customer is very effective (less than 15 minutes). Despite the short
turnaround time, there are several stringent systems, product and process level
controls to manage asset quality. As a strategy to minimize default levels, the
company has introduced many system level controls, wherein loans are not
provided: 1) to jewelers; 2) against gold, bullion and storable forms. The company
also follows a strong hierarchy at branches and regions to ensure alignment of
authority and financial responsibility.
Target customer focus makes MGFL preferred lender vs. banks: Besides
capitalizing on the advantages enumerated above that NBFCs like MGFL enjoy
vs. competition (banks, etc), MGFL, per se, focuses on professions and people
with irregular income streams and on short-term fund requirements of farmers,
agriculturists, small vendors and middle- to low-income groups.
Aggressive branding campaign nation-wide also increasing awareness:
Apart from its rapid branch expansion, MGFL has undertaken an aggressive
marketing campaign in the past 18 months to raise awareness on gold loans and
improve recognition of the MGFL brand. Hence, total advertisement expenses
have increased from Rs119mn in FY09 to Rs483mn in FY10 and Rs825mn in
9MFY11. The increase in brand awareness and aggressive branch rollout will
lead to rise in average ticket size, which will support AUM growth here on.
Recent regulatory issues overdone
NBFCs like MGFL enjoyed benefits (lower) on funding costs owing to gold loans
being eligible earlier as priority sector for banks. However, recently RBI (3
rd
Feb’2011) notified that loans sanctioned to NBFCs for on-lending to individuals or
other entities against gold jewelry are not eligible for classification under the
agricultural sector and securitization/assignments of gold loan portfolios of
NBFCs also do not stand eligible under this classification. The notification is silent
on priority sector status for micro-credit (loans of amount not exceeding Rs
50,000 per borrower) originated by banks either directly or indirectly through a
SHG/JLG mechanism or to NBFC/MFI.
Our views on this issue
Growth impact limited: Growth (volumes) momentum to remain largely
unaffected. The inherent favorable dynamics like under-penetration, 3/4
th
share of
the gold finance market with money lenders, changing psychology of the
borrowers, coupled with MGFL’s efforts over the past three years dedicated at
achieving scale and visibility and strengthening brand image will likely drive
growth here on. ~60% of the branches have been added over the past 15-18
months. We believe that growth may sustain and banks will continue to fund
MGFL owing to its strong capital position, good track record of managing asset
quality and profitability. But the funding costs may rise (discussed below).
Funding costs to rise but to be partly offset by operating leverage: While the
recent RBI guidelines will impact the availability of funding to some extent, we do
not see funding drying up for MGFL, as at 3QFY11 ~45% of its debt funding was
from the non-priority sector route (bank credit lines, CPs, NCDs). Even within the
priority sector, only 35% was from sell-down to banks (a source of concern), while
the remaining 65% were credit lines from banks at slightly lower rates due to the
priority sector tag. Since the cost of funds which came through the priority sector
were ~150-200bp cheaper than normal bank borrowings, removal of priority
sector status would increase the cost of funds for gold NBFCs. While on the back
of this, we factor in NIM compressing by ~200bp in FY11-13, but increased
operational efficiency (opex to avg. assets declining by ~150bp by FY13) should
mitigate the impact on RoA.
Leverage to come off; capital consumption to increase: Gold financing
companies like MGFL were selling ~20-25% of their loan portfolio to banks for
which they were not required to set aside equity capital. Now NBFCs will not be
able to sell their portfolio to banks and will have to keep this portfolio on their
books. Hence the NBFCs will have to set aside the mandatory regulatory capital
of 15% for loans. This means that NBFCs’ ability to leverage would go down. But,
on the contrary it would be cushioned for MGFL, as they have recently raised
capital and have high CAR (Tier 1 of +32%).
Earnings CAGR of +55% during FY10-13E
Despite the recent regulatory issues, as discussed above, we still estimate
MGFL’s profit will grow +115% in FY11 followed by +80% in FY12 and 35% in
FY13. But earnings (EPS) growth is likely to be lower at +70% in FY11E and
+65% in FY12E on recent dilution. Earnings growth to be driven by -
AUM: +85% CAGR in FY08-10; +45% CAGR over FY11E-13E
Gold loan AUM for MGFL has clocked a +85% CAGR over FY08-FY10. Robust
loan growth over this period was also supported by higher gold prices. In
9MFY11, growth remained robust with total AUM rising +150%, despite only
+25% increase in gold prices, signaling strong underlying demand.
We estimate gold loan AUM will cross Rs160bn by FY13 (+45% CAGR over
FY11E-13E). We believe that new branch additions and higher productivity from
branches opened in the past few years would support AUM growth (~60% of its
current branch network added in the past 12 months, where productivity is
significantly lower than that at its established centers).
Not factoring in securitization from FY12 and beyond
We are also not building in any securitization / assignments from FY12E as the
recent RBI circular mandating companies to preserve loans on their b/s for at
least 12 months will play spoilsport if implemented, given MGFL’s average
duration of a loan is only 3-4 months.
Margins high at 11-12%, post correction on RBI directive
MGFL has enjoyed margins in excess of 14-15% as: a) MGFL enjoys high
lending yields at +21-27% (60% of loans) due to shorter maturity of loans and
higher churning of the portfolio, yields turn out to be relatively higher than average
contracted rates and b) it got the benefit of lower funding costs until recently due
to its loans classified as priority sector loans for bank’s priority sector
requirements.
Going ahead, the benefit of lower funding costs will abate due to RBI directive, as
discussed earlier, and also as borrowing rates rise, but we still expect margins to
remain in +11-12% range owing to high loan yields and MGFL deriving benefit of
leverage of QIP float money that it recently raised.
Benefits of operating leverage to kick-in, going ahead
Rapid growth in business and branch distribution and marketing campaign has
led to relatively high cost income ratios for MGFL over the past few years. Also,
given the nature of the business, high staff numbers along with ongoing training is
required, which leads to higher expenses.
MGFL’s operating expenses are primarily fixed in nature. Consequently, with
increasing scale, we believe the cost-to-income (C/I) ratio would decline going
forward, boosting profitability. However, we estimate this would happen only postFY11, when growth in advertising expenses taper down. These expenses
(+Rs1.2bn in FY11E as against Rs0.5bn in FY10) would see the C/I ratio
increasing from ~43% in FY10 to ~48% in FY11E. Thereafter, we expect a
decline to ~40-41% by FY13E. Operating expenses are projected to increase at
~65% CAGR through FY10-13E
Asset quality: healthy
Default rate on gold loans is relatively lower (NPLs less than +0.2-0.3%) due to
cultural legacy/strong sentimental value attached to the pledged jewelry and
physical custody of the asset with the company. With an average LTV of 75%,
risk of default to MGFL is low. Historically, NPLs were high owing to MGFL’s
hypothecation commercial loan portfolio, where gross NPA rose rapidly in FY08
and FY09. However, MGFL has exited that business completely and the
proportion of CV loans has declined from 18% in FY06 to only 1% in FY10.
We expect gross NPA to decline to 0.7% by FY12E from ~1.2% in FY10. We
also note that ~75% of the company’s total outstanding loans have an LTV of less
than 75%. We are factoring in credit costs of 61bp in FY11E and +40-45bps each
in FY12E and FY13E. The higher credit costs in FY11 builds in incremental
provisions of 25bps on standard assets.
Risk management systems tuned to prevent defaults
MGFL starts with Know Your Customer (KYC) norms, where customers are
required to provide only a valid identity proof. There are several stringent
systems, product and process level controls to manage the asset quality. As a
strategy to control default levels, the company has introduced few system-level
controls, wherein loans are not provided: 1) to jewelers; 2) against gold, bullion
and storable forms. The company also follows strong hierarchy at branches and
regions to ensure alignment of authority and financial responsibility.
MGFL carries out several different checks to determine the quality and value of
collateral against which lending is done, each test duplicated at various levels.
Despite a thorough and detailed process of verification/assessment, the
turnaround time is very effective (less than 15 minutes). This is possible due to
training provided and expertise developed to/by the operational staff involved and
the technology platform. MGFL has tried to capture the business intelligence and
risk management process developed over years of lending (pertaining to
methodology of verification, weight/purity adjustments, computation of LTV and
loan amount) onto a common IT platform developed in-house.
Strong physical security
Post verification, every ornament is stored in a safety vault located in each
branch. Vaults have RCC structures on six sides (1.5 ft thick) and keys are
handled by the Branch Head (BH) and Assistant Branch Head (ABH) under dual
custody. Vaults are linked to servers and any break-ins send emergency
message to key management personnel from the Chairman to BH. For inventory
control, daily reports and monthly reports are regularly sent to the HO based on
mandatory checks. Moreover, regional managers and internal auditors verify gold
on a consistent basis and flying squads conduct surprise checks at branches.
Gold price correlation with asset quality
While insulation from a sharp correction in gold prices in few months is low, we
believe there are few controls which can prevent lenders like MGFL from high
defaults. These are enumerated below:
„ MGFL normally provides loans against household-used jewelry and not
against gold bars. They calculate the LTV on the scrap value of the gold.
This improves the margin of safety for MGFL in the event of a fall in gold
prices, as the value of the jewelry is normally ~15-20% higher than the scrap
value of the gold, as it includes the making charges of the jewelry. Hence,
the replacement cost of the jewelry for the borrower is much higher than the
scrap value and this makes willful default less likely, even if there is a
correction in gold price. Hence, effective LTV is only <70-75%.
„ The average duration of the jewelry loans is ~100 days and ~65% of the
loans are repaid within 90 days and 85% within 180 days. Only 15% of the
loans go beyond 180 days. Hence the sector is insulated to a significant
extent from a gradual decrease in gold prices.
„ Some lesser known features of gold financing contracts mitigate to a great
extent the NPA risk in the event of a sharp decline in gold prices: 1) MGFL
has the right to make a margin call if the LTV falls below their comfort level
and; 2) MGFL has the right to sell the pledged gold even before the
completion of loan tenure in case the LTV crosses 90%.
Well–capitalized for the next phase of growth
Recent RBI directive (as discussed above) will result in lower securitization and in
effect higher on B/s loans. But MGFL is well positioned post recent QIP, with Tier
1 of +32% to absorb the higher capital consumption.
DuPont Analysis
We estimate RoAs to sustain at 4.4% and RoEs to expand to +24-25% by FY13
from ~20% in FY11E, but lower than FY10 owing to recent RBI directive, which
will increase MGFL’s funding costs and compress topline (margins). Also,
improving operating efficiency, as pace of branch and staff expansion normalizes,
will also compensate for lower topline and hence RoAs likely to sustain at +4.4%.
There could be further upside to RoAs and RoEs in FY13E from our current
estimate as we build in loan growth of only ~30% in FY13E.
Valuation: Favorable risk-return
MGFL has no listed comparables domestically, but globally we have a few listed
players who are basically into similar business of lending against gold. They are
H&T Group, Inc and Cash America International. Both foreign players are trading
at 1.2-1.6x CY11E book but also have RoEs of only 14-16%.
Valuing MGFL at ~3.2x FY12E adj. book
We initiate coverage on MGFL with a Buy rating. We believe the stock can re-rate
to ~3.2x FY12E book (trades at ~2.8x FY11E book), which is at theoretical
multiples (see assumptions below), as growth potential for MGFL is strong,
considering significantly untapped organized gold loan market in India (~1.2% of
gold stock value) and MGFL’s ability to grow way above average, given its scale,
expertise and brand equity.
Valuing the company on growth-adjusted P/BV method
The P/BV-ROE relationship does not capture the underlying growth potential of
the NBFCs, especially for those whose growth is likely to exceed the “normalized”
growth rate of 6-7% expected in a fast-growing economy like India where real
GDP growth is forecast at +7-8% through FY12 and possibly beyond.
The standard equation below is an example of how growth could be captured and
how the P/BV multiple tends to expand exponentially as growth climbs upwards.
In the equation, “g” stands for the compound annual growth rate:
Fair Value (P/Adj. BV) = (ROAE – g) / (Cost of Capital – g)
We have valued MGFL using the growth-adjusted P/BV method (above equation),
with the following key assumptions:
„ ROE: average 23% (FY11E-13E) owing to dilution; average RoEs at over
35% in FY05-10
„ Cost of equity at 14%
„ Sustainable growth rate of 10%, given MGFL’s ability to gain market share.
Based on the above equation, we believe that MGFL can sustain multiples
in excess of +3.2-3.3x one-year forward, given its ability to grow way above
average, given its scale, expertise and brand equity.
Markets may pay high multiples for high consistent growth/ROEs
We have traditionally valued banks/NBFCs based on P/BV-ROE as we believe
this best captures the risk-return trade-off. The ROE-P/BV relationship, however,
is unlikely to be linear as the ROEs expand beyond the CoEs. Typically, a
company is likely to get a premium over its P/BV multiple as it generates higher
ROE or is relatively better positioned to capitalize on growth opportunities in
India.
If a company like MGFL can generate a stronger ROE compared with its cost of
capital, the growth becomes higher and the multiple expands. The high growth
that is accompanied by a high ROE is valued by the market.
In emerging markets, banks / NBFCs that can provide higher ROEs, with sound
asset quality and strong growth potential, tend to trade at significantly higher
multiples, as is the case with private banks in India. Hence, we believe the
relationship between P/BV and ROE tends to be more exponential as ROEs
expand beyond CoEs.
P/E to gain relevance for high growth & manageable asset quality Co’s
We believe P/E may gain more relevance for companies like MGFL with very high
earnings growth (+55% estimated CAGR through FY10-13) and offering high
comfort on asset quality. Hence, we peg our target price objective at a PE of
~15.5x FY12E earnings, which is in-line with market multiples, but earnings
growth much higher than market earnings growth.
Company description
Manappuram Group was started in 1949 by Late Mr. V. C. Padmanabhan, with
focus mainly on money lending activities. Manappuram General Finance, the
flagship company of Manappuram Group, is the leading gold-loan providing
NBFC based out of Kerala. Mr. V.P. Nandakumar, the present chairman, took
over the reins from his late father in 1986 after his illustrious stint with Nedungadi
Bank. The group has come a long way in 60 years, operating five companies
under its fold, spread over 18+ states with more than 1,950 branches, a total
business of over Rs65bn (AUM) and an employee base of over 14,670, and a live
customer base of over 1mn.
Management
Mr. V.P. Nandakumar is the chairman and Mr. I. Unnikrishnan is the managing
director of the company.
Mr. V.P. Nandakumar (Executive Chairman) is the promoter of the
Manappuram Group of Companies. He holds a masters degree in science from
Calicut University and is also a Certified Associate of Indian Institute of Bankers.
Mr. Nandakumar has been associated with the banking industry in various
capacities. He is the Chairman of the Equipment Leasing Association (India) and
the Kerala Non-Banking Finance Companies Welfare Association.
Mr. I. Unnikrishnan (Managing Director) holds a bachelors degree in
commerce from Calicut University and is a fellow member of the Institute of
Chartered Accountants of India. He has experience in rendering advisory services
relating to NBFCs. He has in the past worked with HAWA-MK Electrical Limited.
He has been the Director of Manappuram since October 11, 2001.
Price objective basis & risk
Manappuram (XCHWP)
MGFL is the second largest NBFC with market share of 7% in organized
segment. We believe stock can re-rate to +3.2-3.3x FY12E book, as 1) we
estimate earnings growth of +55% through FY10-13, 2) MGFL capitalizes on
US$11bn market opportunity growing at +30-35% yoy, with MGFL better
positioned driven by rapidly rising distribution and proven expertise and, 3) asset
quality remains manageable (net NPLs at <0.2%) driven by strong risk
management systems and sentimental value of collateral. Hence, we estimate
above average RoAs (+4.4%) and RoEs (+22-25%) to sustain. Hence, we believe
the stock trading can rerate to +3.2x FY12E book multiples (at Gordon theory
multiples assuming RoE of 23%, CoE at 14% and sustainable growth of 10%), as
growth potential for MGFL is strong. Our Rs 175 price objective implies P/E of
15.5x FY12E EPS, in-line with markets, but with higher earnings trajectory. Key
risks are rise in thefts and frauds and increase in compeitition, which can hurt
growth. In light of RBI's recent actions, while the cost of capital will go up access
to capital also could be challenging as banks may no longer find it attractive to
lend to gold finance companies. MGFL's inability to scale up in a timely manner
its risk management systems in line with expanding business could potentially
lead to asset quality issues.
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