Muthoot Finance IPO Analysis

The largest Gold Financing Company in India

The company has long operating history, sound financials and solid track record, but valuation presumes continuation of high growth which can get constrained due to regulatory changes and increasing competition

Muthoot Finance is the largest gold financing company in India in terms of loan portfolio, according to IMaCS Industry Report (2010 Update). The company provides personal and business loans secured by gold jewellery, or Gold Loans, primarily to individuals who possess gold jewellery but could not access formal credit within a reasonable time, or to whom credit may not be available at all, to meet unanticipated or other short-term liquidity requirements.



Muthoot Finance is a "Systemically Important Non-deposit taking NBFC" headquartered in the southern Indian state of Kerala with an operating history of over a period of 70 years

Muthoot Finance Gold Loan portfolio as of November 30, 2010 comprised approximately 4.1 million loan accounts in India which it serviced through 2,263 branches across 20 states. The company has further increased its branch network to 2,611 branches as of February 28, 2011, servicing an average of 67,953 customers per day in the month of February 2011. As of February 28, 2011, the company has employed 15,664 persons. According to the IMaCS Industry Report (2010 Update), as of March 31, 2010 Muthoot Finance branch network was the largest among gold loan NBFCs in India.

In the years ended March 31, 2008, 2009 and 2010, and in the eight months ended November 30, 2010, revenues from Gold Loan business constituted 95.97%, 96.71%, 98.08% and 98.50%, respectively, of its total income. In addition to Gold Loans business, the company provides money transfer services through its branches as sub-agents of various registered money transfer agencies, and recently has commenced providing collection agency services. The company also operates three windmills in the state of Tamil Nadu.

Muthoot Finance customers are typically small businessmen, vendors, traders, farmers and salaried individuals, who for reasons of convenience, accessibility or necessity, avail its credit facilities by pledging their gold Jewellery with Muthoot rather than by taking loans from banks and other financial institutions. The company provides retail loan products, primarily comprising Gold Loans. The company also disburses other loans, including those secured by Muthoot Gold Bonds. Its Gold Loans have a maximum 12 month term. Its average disbursed Gold Loan amount outstanding was Rs 31,553 per loan account as of November 30, 2010. In the year ended March 31, 2010, its retail loan portfolio earned, on average, 1.67% per month, or 19.94% per annum, and in the eight months ended November 30, 2010 its retail loan portfolio earned, on average, 1.57% per month, or 18.92% per annum.

As of March 31, 2008, 2009 and 2010, and November 30, 2010, its portfolio of outstanding gross Gold Loans under management was Rs 2179.01 crore, Rs 3300.07 crore and Rs 7341.73 crore, and Rs 12897.77 crore, respectively, and approximately 30.1 tons, 38.9 tons and 65.5 tons, and 97.6 tons, respectively, of gold jewellery was held by the company as security for its Gold Loans. Gross non performing assets ("NPAs") were at 0.42%, 0.48% and 0.46%, and 0.35% of its gross retail loan portfolio under management as of March 31, 2008, 2009, 2010, and November 30, 2010, respectively.

As of November 2010, Muthoot finance funding sources constituted- 37.5% of Working Capital Loans, 27.3% NCD-Retail, 26.3% Bilateral Assignments, 4.1% subordinated debts, 3.6% commercial papers and the balance from loans from Directors or relative of directors, term loan and overdraft facility from Banks, Unsecured bank loan and Inter corporate loans.

The company is coming with an IPO to raise around Rs 901 crore at the upper band of Rs 175 per share and Rs 824 crore at the lower band of Rs 160 per share consisting of a fresh issue of 5.15 crore equity shares and. Post issue Muthoot Finance promoters holding will fall to 80.12% from 93%. Currently the balance 7% is owned by Matrix Partners, Barings Private Equity India, Kotak Private Equity and the Welcome Trust.

The company intends to utilize the net proceeds to augment its capital base to meet its future capital requirements to provide for funding of loans to its customers and general corporate purposes.

Muthoot Finance and Muthoot Fincorp

Muthoot Finance is a non deposit taking NBFC headquartered in kerala with an operating history of over 70 years since M George Muthoot (father of the Promoters) founded a gold loan business in 1939 under the heritage of a trading business established by his father, Mr. Ninan Mathai Muthoot, in 1887.

Muthoot Fincorp is a NBFC registered with RBI and not in the listed space. Muthoot Fincorp is a group company of Muthoot Capital Services Company which is listed in BSE. Muthoot Fincorp as well as Muthoot Capital Services belongs to the Muthoot Pappachan Group. Muthoot Pappachan Group was founded by Mathew M. Thomas or Muthoot Pappachan, youngest son of Mr. Ninan Mathai Muthoot. Notably Muthoot Fincorp is also a leading player with significant market share in loan against gold business.

Key Industry Characteristics- Gold Loan Market

Market is largely unorganized dominated by small ticket loans usually through local moneylenders

Organized players add significant value in terms of standard practices and ethics

Entry of nationalized banks and new generation private sector banks has addressed issue of social stigma- Old private sector banks especially based in Kerala have long history in this business

Gold loans perceived as a convenient source of short term/bridge financing- Customer service, speed and convenience are key business drivers

Huge sentimental value attributed to personal jewellery/gold – ensures high recoverability

Ticket size of loans and effective maturity generally smaller considering target customer segment – mitigates risk of interest rate volatility

Interest rate sensitivity on a small ticket loan is relatively low

Strengths

As per IMaCS Industry Report 2009 the Gold Loans market is expected to grow at between 35% and 40% over the next three years. Moreover, as the market is currently under-penetrated, it is expected that the Gold Loans market will offer enough opportunities for portfolio expansion and retain attractive margins for all existing specialized NBFCs, banks and new entrants.

The company has an operating history of over a period of 70 years. It gives them an edge in terms of capabilities, trust and expertise.

Gold as collaterals with a LTV raging from 60-85% gives robust security to amount lent. Also Sentimental value for personal jewellery ensures high recoverability. So, the chances of NPAs are relatively lower. Net NPAs as a percentage of Gross retail loans stood at a minimal 0.46% at the end of FY'10.

Maximum tenure for loans is 1 year while average maturity is approximately 3-6 months. So the business not adversely impacted by the gold price fluctuation. Also Small ticket size loans lowers risk/impact of bad loans

Business model ensures a positive ALM ( Asset Liability Match) as loan maturity are of less than a year and borrowing tenure is greater than a year.

The company has a strong presence in under served rural and semi urban markets where majority population has limited access to credit.

India is one of the largest markets for gold accounted for approximately 10% of total world gold stock as of FY'10 with 18000 tonnes of gold.

Weaknesses

Interest rate charged by banks for Gold loans vary from 8-10% in case of loans for agricultural purposes and approximately 12-13% on loans for non agricultural purposes while NBFCs charge between 22-26% approximately for the same Gold loan which is not sustainable in the long run and regulatory cap may come at some level.

With increased attractiveness of Gold loans commercial bank as well as other NBFCs are also foraying into Gold loans thereby increasing competition.

Gold loan market is highly concentrated in southern India accounting for almost 85% to 90% of the total market. Rest of India is still to catch up or accept Gold loan concept. At the end of Feb '28, 2011 Muthoot finance's 67% branches were located in Southern India, 18% in North India, 11% in Western India and 4% in the Eastern India.

Promoters plan to register the "Muthoot" logo and other combination marks in their names. Pursuant of which the promoter proposes a non exclusive license to use the Muthoot Trademark for an annual royalty equivalent to 1% of the gross income of the company, subject to a maximum of 3% of profit before tax (after charging the royalty) and managerial remuneration payable by the company each financial year. This will reduce profits to that extent as currently no royalty is charged.

There is an ambiguity on whether or not NBFCs are required to comply with the provisions of state money lending laws that establish ceilings on interest rates. The company received show cause notices from certain Government authorities in relation to compliance with relevant money lending statutes in relation to its operations in the states of Gujarat and Kerala. Further if provisions of any state specific regulations are extended to NBFCs in the gold loan business it would mean increased costs of compliance.

The company is exposed to operational risks, including employee negligence, fraud, petty theft, burglary and embezzlement as it handles high volume of cash and gold jewellery in a dispersed network of branches

A recent notification issued by the RBI in February 2011, has stipulated that loans sanctioned to NBFCs for on lending to individuals or other entities against gold jewellery would not be eligible for classification as priority sector advances. This means higher cost of funds for the NBFCs.

The Promoters, Directors and related entities of the company have interests in a number of entities, which are in similar businesses and this may result in potential conflicts of interest.

Valuation

Muthoot Finance annualized EPS for 8M FY 2011 on post-issue equity works out to Rs 11.8. At the price band of Rs 160 to Rs 175 P/E works out to 13.6 to 14.9 times. Manappuram General Finance and Leasing Company (MAGFIL) another Gold loan company with less than half of its size in terms of income is currently trading at P/E of 22.4.

Current book value of Muthoot Finance is just Rs 35. Post-issue Book Value works out to Rs 52.6 and Rs 54.7 at issue price of Rs 160 and Rs 175, respectively. P/BV at both the bands works out to be 3.0 and 3.2 times, respectively. MAGFIL is currently trading at a P/BV of 2.9