Muthoot Finance: Getting back on track

Initiating Coverage

Muthoot

Financials

| Sector:

Finance

Muthoot Finance

BSE Sensex

26,933

S&P CNX

8,153

CMP: INR163

TP: INR234 (+44%)

Buy

Getting back on track

Good franchise available at attractive valuations



Stock Info

Bloomberg

Equity Shares (m)

M.Cap. (INR b)/(USD b)

52-Week Range (INR)

1, 6, 12 Rel. Per (%)

Average Value (INR m)

Free float (%)



MUTH IN

398.0

64.9/1.0

254/152

-7/-13/-20



25.2

Financial Snapshot (INR billion)

Y/E March

2016E 2017E 2018E

NII

24.5 28.3 33.5

PPP

PAT

EPS (INR)

BV/Sh.(INR)

RoA on AUM (%)

RoE (%)

Div. Yld. (%)

Valuations

P/E (x)

P/BV (x)

12.5 14.9 18.7

7.9

9.4 11.8

19.8 23.7 29.7

140.6 155.9 175.2

3.1

3.6

8.2

1.2

3.2

4.4

6.9

1.0

3.4

5.5

0.9

14.7 16.0 18.0

Gold loan penetration levels remain low and addressable market very large; niche

expertise and single product focus will be the growth enablers.

Regulatory environment has stabilized, competitive intensity has reduced and gold

prices are stable; the largest incumbent Muthoot Finance with over 4200 branches

and INR244b AUM to gain the most from growth revival.

Loan growth showings signs of revival; massive operating leverage could kick in as

80% of the costs are fixed in nature and existing infrastructure is underutilized.

Better margins, operating leverage to drive profitability; RoEs bottomed out at

14.3% in FY15 from peak of 51% in FY11; expect improvement from here on in.

Current valuations of 6.9x FY17E P/E and 1x FY17E BV are attractive. Initiate

coverage on Muthoot Finance (MUTH) with a Buy rating and target price of INR234

(a 44% upside).

Stable regulatory environment:

Post a stellar run during FY08-12, India’s gold

finance NBFCs have undergone significant turmoil in the past three years—led by

changing regulatory landscape and steep decline in gold prices. However, the

industry has started to stabilize and is poised to return to growth from here on in,

with gold financing NBFCs following stricter regulatory norms than most other

asset financing NBFCs. The competitive intensity has also rationalized with many

new/smaller players exiting the segment. We are positive on the industry and

believe the gold monetization theme will gather pace; with its market leadership

position and clean track record, MUTH is well placed to tap this opportunity.

Growth reviving; operating leverage to kick in:

After a prolonged lull, the

business is reviving (AUM grew 14/4% YoY/QoQ in 1QFY16) on the back of stable

gold prices, management’s concentrated marketing efforts, launch of new gold

loan products, and branch activation by imbibing customer acquisition culture. In

our view, pick-up in growth could lead to massive operating leverage as 80% of

the costs are fixed in nature and the existing infrastructure (4250 branches &

22000+ employees) has been underutilized due to decline in business.

Gold loan penetration low; niche expertise will be the growth enabler:

Low

gold

loan penetration and large addressable market provide enough growth

headroom. Moreover, niche expertise and single product focus (enabling strong

understanding of customer needs like quick turnaround time and minimal

documentation) will continue to be the growth enablers.

Strong franchise, healthy return ratios; valuation ripe for re-rating:

Regulatory

environment has turned favorable and business momentum is picking up. We

expect +17% loan CAGR for the next 3 years. Also, given that 80% of MUTH’s

operating costs are fixed in nature, rebound in business will lead to optimum

utilization of existing infrastructure. RoEs bottomed out at 14.3% in FY15 from the

peak of +51% in FY11; expect gradual improvement from here on in. Revival in

business and improving return ratios make current valuation of 6.9x FY17E and 1x

FY17E BV attractive. We initiate coverage with a

Buy

rating and a target price of

INR234, whereby the stock would trade at 1.5x FY17E BV (a 44% upside).

Shareholding pattern (%)

As on

Jun-15 Mar-15 Jun-14

Promoter

74.8

75.0

DII

5.2

5.1

3.2

FII

11.1

14.2

Others

8.9

9.0

7.6

FII Includes depository receipts

Stock Performance (1-year)

Muthoot Finance

Sensex - Rebased

250

220

190

160

130

6 October 2015

Muthoot Finance

Stable regulatory regime

NBFCs’ gold lending norms at par with banks



RBI’s acceptance of KUB Rao committee’s recommendation to increase the LTV to 75%

makes the business viable for gold NBFCs.

Regulations favoring level playing field (capping LTV for banks at 75%) indicate that

regulatory tightening is over and the business can operate with a fair degree of

regulatory certainty.

Stricter regulatory framework has de-risked the business model of NBFCs.

Gold loan NBFCs returning to stability post the storm

Post a stellar run during FY08-12, India’s gold finance NBFCs have undergone

significant turmoil in the past three years—led by the changing regulatory landscape

and steep decline in international and domestic gold prices. While stricter norms led

to a slowdown in growth, steep decline in gold prices brought asset quality

pressures; this forced most gold-financing players to shrink their loan books over the

period.

In our view, the industry has started to stabilize now and is poised to return to

growth from here on in as:



The regulatory environment has stabilized with gold financing NBFCs following

stricter regulatory norms than most other asset financing NBFCs



Competitive intensity has rationalized with many smaller players exiting this

segment and market shares starting to consolidate with fewer and larger banks

and non-banking finance companies



International gold prices have already declined substantially



Domestic economic revival is likely to boost demand for loans again, especially

in the small and mid-sized towns and rural centers



Asset quality concerns have stabilized as most of the pain is over and should

abate over the medium term.

Regulatory framework de-risked the business; level playing field a key

positive

RBI capped LTV for banks at

75%, thus bringing lending

against gold parity for gold

NBFCs vis-à-vis the banks

Multiple rounds of regulatory tightening for the last two years led to a fair degree of

de-risking in the gold loan business. Moreover, new norms have ensured level

playing field for NBFCs—a key long-term positive for the sector.

The central bank has a) allowed banks to offer bullet products for gold loan (bullet

payment product is the most popular form of gold loans, which was not allowed

earlier); b) capped LTV for banks at 75% for lending against gold (earlier banks had

no LTV cap), citing the need for a level playing field. These developments are vital

from gold NBFCs’ point of view as the regulatory measures were not conducive to

their growth in the past.

RBI’s move indicates acceptance of gold NBFCs’ business model

Incumbents in a much

better position now

New regulatory framework by RBI marks a noticeable change in its stance on gold

loan NBFCs. It acknowledged that growth rates of gold loan NBFCs have moderated

and they represent an organized channel of monetizing idle gold. RBI seems to be

6 October 2015

Muthoot Finance

comfortable with the idea of gold loan NBFCs restarting their loan book growth.

RBI’s decision has given a new lease of life to gold NBFCs and we believe it will auger

well for their future growth and earnings.

Fear of de-growth fades

While the fear of another round of loan book de-growth completely fades away, the

higher LTV regime will allow gold NBFCs to recoup some of the lost business. This,

coupled with reduced competitive intensity, will ensure a revival in loan book

growth for incumbents like MUTH from FY16 onwards.

Exhibit 1: Summary of regulatory guidelines - KUB Rao committee and final RBI recommendations

Key parameters

Loan to value ratio

KUB Rao recommendation

Suggested increasing LTVs from

60% to 75% of the scrap value

Final RBI guidelines

After refraining for some time, RBI

accepted and increased the LTV to

75%; LTV capped at 60% of scrap

value

Comments

Positive for gold loan NBFCs as

their LTVs have increased and

banks’ LTVs are now at par

with NBFCs

Level playing field

Suggested level playing field for

banks and NBFCs

Valuation techniques

30-day average price of 22 carat

gold prevailing in Bombay Bullion

Association

Prior approval from RBI for more

than 1,000 branches

RBI takes key steps to ensure level Positive for gold NBFCs—RBI’s

playing field: 1) LTVs @75% for

measures to ensure level

both banks and NBFCs, 2) allowed playing field

banks to offer bullet products

30-day average price of 22 carat

gold prevailing in Bombay Bullion

Association

Prior approval from RBI for more

than 1,000 branches

No impact: MUTH already has

over 4,200 branches and does

not intend to open more than

300 branches every year

Negative impact: Although

incremental ticket size for

MUTH is INR40,000, this will

shore up operating costs

Minor impact: Average ticket

size is almost half of the

proposed limit

Source: Company, MOSL

Branch opening licenses

Verification of gold ownership

Not recommended

Verification of gold ownership if

pledged amount >20gms

Cash disbursement

Disbursements > INR200,000

should be done in cheque

Disbursements > INR100,000

should be done in cheque

6 October 2015

Muthoot Finance

Growth showing signs of revival

Benign competition and marketing efforts to help recoup lost business



Increase in LTVs and reduction in competitive intensity would help grow the loan book

and recoup lost business.

Growth showing signs of revival, with MUTH registering the second consecutive

quarter of positive YoY growth after five quarters of decline.

Assertive marketing efforts and new product launches aiding growth revival.

Sales push strategy to be the driver of incremental growth.

LTV cap hurt the business, eroded competitive edge

The two most critical elements of gold financing business are a) quantum of LTV

offered and b) turnaround time. LTV cap at 60% had put the gold loan NBFCs at a

significant disadvantage, as banks did not have any LTV cap on gold loans and

money lenders are not regulated. MUTH’s loan book declined since the cap was

introduced and it lost business to cooperative banks and unorganized players as

customers migrated seeking higher LTVs.

An average household has a limited quantity of gold to pledge, with the average

being 40-45 grams. Given that the average duration of loans is 3-4 months, the

entire loan portfolio was getting re-priced at lower LTVs. This is reflected in the

below chart, which shows flat AUM growth for MUTH for the last three years.

As lending yields are less on lower LTV loans and 80% of the company’s operating

expenses are fixed in nature, the impact on profitability was severe—MUTH’s RoE

fell from 42% in FY12 to 14.3% in FY15). Hence, an increase in LTV to 75% is a huge

positive and relief for the company, ensuring the viability of its business model.

Exhibit 2: AUM growth stagnant for the last three years

264

AUM (INRb)

258

244

226

219

215

218

221

234

244

233

237

257

Flat AUM growth since last 3 years

Source: Company, MOSL

Competitive intensity reduced; incumbent to gain as business turns around

The competitive intensity, which was on the rise during the heady growth period of

2008-12 owing to the entry of new players in the segment (especially the larger

banks), declined substantially after the regulatory clampdown.

6 October 2015

Muthoot Finance

With growth slowing down, several players reduced focus or exited this segment. In

our view, this would benefit the largest incumbent Muthoot as the growth returns.

Exhibit 3: Gold loan YoY growth in FY15

FY15

17.5

8.0

(2.5)

(5.2)

20.7

0.4

(16.2) (26.8)

MUTH MGFGL SCUF

IIFL

Federal HDFC

Bank

CUB

SIB

18%

Source: MOSL

Exhibit 4: MUTH remains the largest player (FY15)

MUTH

Federal Bank

MGFGL

HDFC

43%

SCUF

CUB

IIFL

SIB

Source: MOSL

Muthoot remains the largest private sector player in the lending against gold

segment (excluding agri loans collateralized against gold by PSBs), followed by

Manappuram and then some of the private banks.

Gold prices have largely remained steady for the last one year

Global gold prices are down 40% from their peak of USD1,900/oz over the past 36

months, while domestic gold prices are 20% lower from the peak of 2013 to

INR2,600 per gram. Deterioration in MUTH’s asset quality in 4QFY13 was on the

back of sharp decline in global gold prices, which declined from INR3,110/gm to

INR2,400/gm (~23%) within a five-month period. However, Indian gold prices have

remained broadly stable over the past year—hovering around INR2,500/gm, leading

to stabilization in asset quality.

Exhibit 5: Indian gold prices have broadly remained stable since 2014

3,100.0

2,900.0

2,700.0

2,500.0

2,300.0

2,100.0

Gold price (INR /gram)

Gold prices have broadly remained stable

Source: MOSL

Business momentum building up

AUM accretion has been a key monitorable for Muthoot. In 1QFY16, AUM grew 14%

YoY/4% QoQ to INR244bn—the fourth consecutive quarter of positive sequential

growth after five quarters of decline. Growth was largely driven by improving

volumes (gold tonnage grew 5% QoQ) on the back of various sales initiatives

undertaken over past few quarters.

6 October 2015

Muthoot Finance

Gold loan per branch growth has gone up to INR57.4mn (versus INR50mn earlier) on

the back of focused efforts at branch level. Moreover, the number of gold loan

accounts has increased to 6.5mn (versus 5.6mn in the same quarter last year and

6.2mn in FY15). The gradual increase in business loan book, loan per branch and

increasing customer count is indicating of buildup of positive business momentum.

Exhibit 6: AUM growth has bottomed out

AUM (INRb)

YoY Growth (%)

13.7

2.8

226

219

-12.1

244

-17.1

215

-17.0

-2.2

-10.7

218

221

234

244

7.1

0.1

(6.5)

(19.4) (20.5) (18.4)

(1.0)

(10.6)

8.7

Exhibit 7: Average loan/branch growing on YoY basis

Avg Gold Loans/Branch (INR Mn)

YoY Growth (%)

15.1

Source: Company, MOSL

Marketing efforts and new product launches aiding growth revival

The slowdown in gold loans over the past three years (on the back of 75% loan book

CAGR during FY2007-12) has likely prompted the company to get more assertive on

marketing, a deviation from the transaction-oriented approach followed earlier.

Owing to the regulatory tightening on various fronts, many customers migrated to

the unorganized sector and banks seeking higher LTVs. A majority of the business

was lost due to lower LTVs. However, the management is making concerted efforts

to market gold loans. The company has recently launched gold loan products (such

as home loan margin funding facility and gold overdraft facility) for the middle class.

Exhibit 8: AUM to grow gradually; we expect AUM CAGR of 17% over the next three years

AUM (INRb)

113.3

247

159

55.5

264

6.9

219

(17.1)

234

7.1

268

14.6

AUM Growth (%)

309

15.0

18.0

120.8

364

Source: Company, MOSL

Further growth to come from sales ‘push’ strategy

MUTH’s business was earlier driven by ‘pull’ strategy where customers needing loan

would come to the branch, pledge their gold and avail the loan. Thus, having a

widespread presence was the key for AUM growth and this resulted in rapid branch

expansion. As a result, AUM posted a 53% CAGR during FY10-13—led by a 37%

growth in branches during the period.

6 October 2015

Muthoot Finance

However slowdown in the gold loan market has prompted company into more

assertive marking and exit from transaction oriented approach earlier. With LTVs

increased to 75%, MUTH is focusing on ‘push’ strategy where the company is getting

in touch with old customers (who migrated to banks and unorganized players

seeking higher returns) and luring them back with increased LTV of 75%. To expand

its client base, MUTH is also looking for references from its existing customers. Also

the company has launched gold loan products catering to middle-class like home

loan margin funding and gold loan overdraft facility. This strategy has started

yielding results, with MUTH registering 13.7% YoY growth in AUM in 1QFY16, after

five consecutive quarters of decline.

Exhibit 9: Growth in branch network led to increase in AUM

Growth in Branches (%)

120.8

113.3

53.4

28.3

51.3

62.9

39.3

70.3

34.6

11.0

(17.1)

FY08

FY09

FY10

FY11

FY12

FY13

FY14

(0.6)

FY15

55.5

6.9

4.6

7.1

Growth in AUM (%)

Source: Company, MOSL

These efforts are gradually yielding results and will drive superior loan growth over

time despite volatility in gold prices. Muthoot’s gold loan book declined QoQ from

1QY14 to 1QFY15, but since 2QFY15 has been inching up gradually, it grew 1.6%

QOQ in 2QFY15, 6% in 4QFY15 was up +4% QoQ in 1QFY16. We expect this

momentum to drive 17% CAGR over next 3 years.

6 October 2015

Muthoot Finance

Operating leverage to kick in

On the back of growth revival



Increased usage of existing infrastructure to bring in operating leverage.

Branch rationalization underway— incremental branch additions stood at 200 every

quarter till two years back; in FY15, MUTH closed 26 branches.

Cost-to-income ratio to decline to 45% by FY15 from the existing +52%.

Margins to benefit from falling wholesale rates.

Most of the branch

expansion is already done.

Hence, increased use of

existing infrastructure

would ensure lower

opex/asset ratio, which will

boost profitability

Increased usage of existing infrastructure to bring operating leverage

As the growth returns, MUTH will benefit through greater branch utilization and

larger ticket sizes through better operating cost efficiencies. Improved business

would also ensure lower opex/asset ratios. Given that lending yields are more on

higher LTV loans and 80% of the company’s operating expenses are fixed in nature,

it will positively impact profitability. While AUM will grow at 17% CAGR by FY18, the

profit growth will be over 21% due to significant benefits of operating leverage.

Exhibit 10: Network of over 4,220 branches is the largest among NBFCs

Branch Network

4,082

3,780

3,853

3,914

4,163

4,229 4,260 4,270 4,271 4,265 4,256 4,245 4,242

Source: Company, MOSL

MUTH’s branch network grew almost 4x (in the last five years)—from 985 at end-

FY09 to over 4,220 branches in FY15. However, in the absence of growth, most

branches remained underutilized. The company is present in over 26 states and with

most of the expansion over, it has slowed down the incremental branch additions.

Till two years ago, incremental branch additions stood at over 200 a quarter.

However since last six quarters MUTH has now started to rationalize the branch

network by merging few of the branches; in FY15, MUTH has closed 26 branches.

Exhibit 11: Branch rationalization underway—additions have declined significantly

Branches are likely to

witness positive traction

as growth resumes

264 277

206 198

102

Qtrly branch addition

168

-6

-9

-11

-3

Source: Company, MOSL

6 October 2015

Muthoot Finance

The sharp surge in cost

ratios was due to

underutilization of

infrastructure. With growth

likely to resume, cost ratios

will improve in the

ensuing quarters

Exhibit 12: Cost–to-income to decline to 45% by FY18

Cost income ratio (%)

52.0

46.7

43.4

37.7

37.0

37.6

50.6

48.6

45.5

FY10

FY11

FY12

FY13

FY14

FY15

FY16E

FY17E

FY18E

Source: Company, MOSL

Margins to benefit from falling wholesale rates

MUTH’s margins declined sharply following the decline in gold prices as increase in

stressed assets led to interest reversal. Nonetheless, the margins have bottomed

out at 9% owing to stabilizing gold prices and regulatory measures that reduced

stressed assets. Further, MUTH benefits from a fall in wholesale funding rate as

~50% of its borrowings are from NCDs. Additionally, banks have started to reduce

their base rates following the 125bps reduction in interest rate by RBI. In our view,

MUTH’s margins will gradually improve from here on in and increase to 9.8% in

FY16.

While AUM will grow at 17

CAGR by FY18, PAT is likely

to grow over 21% due to

operating leverage

Exhibit 13: NIMs bottomed out; to gradually improve from here on in

NIMs (%)

10.6

9.9

9.4

9.5

9.8

9.7

9.6

FY12

FY13

FY14

FY15

FY16E

FY17E

FY18E

Source: Company, MOSL

Earnings growth to be higher than loan growth due to operating leverage

Despite the multiple challenges faced by MUTH, the profitability has remained

strong with RoA of 2.6% in FY15. The company’s ROE was as high as 51.5% in FY11

(during the peak of heady growth), as leverage was also high at ~9.0x. However,

decline in profit owing to stringent regulations and correction in gold prices led to a

decline in leverage—from 9x in FY11 to 3.9x in FY15; thus, ROE too declined (from

51.5% in FY11 to 14.3% in FY15). ROA also declined during this period (from 4.9% to

2.6%).

6 October 2015

Muthoot Finance

Exhibit 14: Decline in leverage...

Leverage (x)

8.6

9.0

8.9

6.6

6.4

4.6

3.8

47.9

51.5

41.9

30.2

19.5

4.5

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY10

4.9

FY11

4.8

FY12

3.8

FY13

2.8

FY14

14.3

2.6

FY15

Exhibit 15: …led to a sharp fall in ROE

ROAA (%)

ROAE (%)

Source: Company, MOSL

Exhibit 16: Operating leverage will result in PAT CAGR of 21% for the next three years

133

PAT (INRb)

117

7.8

(22)

2.3

FY10

4.9

FY11

8.9

FY12

10.0

FY13

FY14

FY15

(14)

7.9

FY16E

9.4

FY17E

11.8

FY18E

6.7

PAT Growth (%)

Source: Company, MOSL

In our view the decline in loan growth has bottomed out, as MUTH has registered

second YoY growth in AUM in the quarter gone by after five quarters of decline. We

expect operating leverage to kick-in as the growth revives, and believe the

company’s RoE and RoA would increase to 18% and 3%, respectively, by FY18.

Exhibit 17: AUM growth has bottomed out

AUM (INRb)

YoY Growth (%)

7.1

226

-12.1

244

-17.1

-17.0

219

215

-10.7

218

221

234

244

2.8

FY14

Source: Company, MOSL

2.6

FY15

2.7

FY16E

2.8

FY17E

3.0

FY18E

-2.2

13.7

19.5

14.3

14.7

16.0

Exhibit 18: Return ratios to improve as growth resumes

ROAA (%)

ROAE (%)

2.8

18.0

Source: Company, MOSL

While AUM growth will rebound to 17%, the boost to earnings will be higher at+

21% due to operating leverage.

6 October 2015

Muthoot Finance

Exhibit 19: PAT run-rate maintained at ~INR2b/quarter in challenging times

PAT (INRb)

1.9

2.2

2.5

2.4

2.5

2.7

2.2

1.9

2.1

1.9

1.8

1.7

1.5

1.7

1.8

Source: Company, MOSL

Cost ratios to improve as the growth revives

Decline in AUM growth led to a sharp increase in cost ratios for MUTH, with cost-to-

income ratio rising to decadal high of 52%. This is primary because the infrastructure

to handle and store physical gold is being underutilized as average AUM per branch

declined from its peak of INR67.1m in FY12 to INR55.1m in FY15.

Exhibit 20: Cost-to-income ratio is at decadal high

Cost income ratio (%)

43.4

46.7

37.7

37.0

37.6

52.0

58.1

46.3

Exhibit 21: As business per branch has been on decline

AUM Per branch (INR m)

67.1

64.6

51.2

55.1

FY10

FY11

FY12

FY13

FY14

FY15

FY10

FY11

FY12

FY13

FY14

FY15

Source: MOSL, Company

However, with a rebound in business, we expect the company to quickly ramp up its

operations and lead to optimum utilization of existing infrastructure. This would

result in operating leverage kicking in, with cost-to-income ratio improving to 45%

by FY18.

6 October 2015

Muthoot Finance

Asset quality: Worst phase behind, credit cost to stay low

NPL issues well managed in turbulent times



Even as gold prices fell by over 25%, MUTH was able to contain its NPLs at ~2% .

Credit cost to remain low at ~30bp.

Healthy capital position and low leverage of 3.9x to ensure growth without dilution.

Asset quality issues well managed despite unfavorable environment

Post the sharp decline in gold prices during March-June 2013, certain gold loan

NBFCs faced asset quality issues. However, MUTH managed the situation well—

reflected in 2% GNPAs despite unfavorable regulatory environment coupled with

sharp volatility in gold prices. The company is also maintaining a standard asset

provisioning of 0.4% compared with the mandated regulatory requirement of

0.25%.

MUTH’s NPAs shot up by 50bp in 4QFY13 to 2% owing to a sharp fall in gold prices.

However, the NPAs since then have broadly remained at the same levels and

touched 2.1% in 1QFY16. In our view, the regulatory changes, which capped the

LTVs at 75%, have played a crucial role in stabilizing the asset quality. Further, we

expect stabilizing gold prices and lower LTVs to aid in reducing stress over the

medium term.

Exhibit 22: Gold prices declined ~23% in five months…

Gold price (INR /gram)

3,200.0

3,000.0

2,800.0

2,600.0

2,400.0

2,200.0

Jul-13

Aug-13 Sep-13 Oct-13 Nov-13 Dec-13

Source: MOSL

0.6

0.5

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

Source: MOSL

1.3

1.1

1.4

1.2

1.5

1.7

1.3

Exhibit 23: …leading to 50bp increase in NPAs

GNPA (%)

NNPA (%)

2.0

MUTH’s credit costs have remained low at ~30bp, as principal loss on gold loans has

been minimal owing to the highly liquid nature of the collateral. However, most of

the asset stress is reflected in haircuts on realized interest—which has taken a hit in

the last few quarters and is down to 19% (v/s 23-24% on a normalized portfolio).

6 October 2015

Muthoot Finance

Exhibit 24: Asset quality has stabilized at ~2%

GNPA (%)

NNPA (%)

1.73

1.58

1.88

0.41

0.46

FY10

0.49

0.25

0.29

FY11

0.56

FY12

1.99

FY13

1.90

FY14

2.19

FY15

Source: Company, MOSL

Given the highly liquid nature of the collateral, we expect the loan loss coverage

ratio to remain low (FY15: 14.2%) as likely losses on bad loans under a recovering

economy are expected to be minimal. However, a steep decline in the global gold

prices in a short period of time remains a key asset quality risk for the company.

Exhibit 25: Credit to remain below 30bp

Credit Cost (%)

0.37

0.25

0.18

0.16

13.0

13.3

Exhibit 26: PCR to remain low at 22%

Provision Coverage Ratio (%)

17.4

14.2

19.5

16.8

21.6

0.21

0.20

0.21

FY12

FY13

FY14

FY15

FY16E

FY17E

FY18E

FY12

FY13

FY14

FY15

FY16E

FY17E

FY18E

Source: Company, MOSL

Exhibit 27: Despite adversities, NPLs remained under control

GNPA (%)

NNPA (%)

NPLs increased, but were

contained below 2%

Source: Company, MOSL

Healthy capital position, low leverage to ensure growth without dilution

MUTH has a capital adequacy of +24%, with Tier 1 ratio of ~20%. The current capital

levels are comfortably above the regulatory requirement of 15% and 12% for total

CAR and Tier 1, respectively. The company last raised equity of ~INR4b via QIP in

Q1FY15. It is operating at a low leverage of 3.9x—a decadal low—against the norm

6 October 2015

Muthoot Finance

of 6-7x in the industry. Thus, the current capitalization levels would ensure healthy

growth without dilution.

Exhibit 28: Low leverage to ensure healthy growth without dilution

CAR

Tier 1 (%)

24.7

15.8

18.3

19.6

18.0

10.6

12.8

13.4

20.0

24.8

FY11

FY12

FY13

FY14

FY15

Source: Company, MOSL

6 October 2015

Muthoot Finance

Valuations ripe for re-rating

Rebound in business will lead to valuation re-rating



Regulatory environment turning positive; bodes well for growth and return ratios.

Around 80% of MUTH’s operating costs are fixed in nature and a rebound in business

will lead to optimum utilization of the existing infrastructure. The benefits of scale and

operating leverage will enable MUTH to post 3% RoA and +18% RoE by FY18.

Pick-up in business and gradual improvement in return rations make the current

valuation of 6.9x FY17E and 1x FY17E BV attractive.

We initiate coverage on MUTH with a Buy rating and a target price of INR234, valuing

at 1.5x FY17E BV.

RoEs troughed out at 14.3%

in FY15, from the peak of

+51% in FY11. Gradual

improvement in return

ratios make current

valuation of 6.9x FY17E and

1x FY17E BV attractive

Over last three years the gold loan industry has been dragged down by various

regulatory pressures. However, with most negatives now waning several regulatory

hurdles are behind leading to strengthened practices, the RBI is acknowledging the

systemic importance of gold loan companies, and macros are improving. We expect

this space to gather momentum going ahead. Muthoot, being a lead player in the

sector underpinned by sound brand, extensive franchise and superior operations,

will be a key beneficiary of improving environ and bolster its market share.

MUTH is the largest organized player in the gold loan financing sector. With the

regulatory environment turning favorable, we expect growth to resume and AUM to

grow at CAGR of +17% for the next 2-3 years. Given that 80% of the company’s

operating costs are fixed in nature, a rebound in business will lead to optimum

utilization of the existing infrastructure.

The benefits of scale and operating leverage will enable MUTH to improve return

ratios here on in. Higher return ratios (RoA of 3% and RoE of over 18%) make

current valuation of 6.9x FY17E and 1x FY17E BV really attractive. The stock trades at

a discount to its historical P/B average of 1.5x and also at a steep discount to asset

finance companies like SHTF & MMFS (with similar Roe Profile) which trade at ~2x 1

year forward P/B. We initiate coverage with a

Buy

and a target price of INR234,

whereby the stock would trade at 1.5x FY17E BV (a 44% upside).

Exhibit 29: RoEs bottomed out at 14.3% in FY15, expect improvement from here on

47.9

51.5

41.9

30.2

19.5

14.3

2.6

FY15

14.7

2.7

FY16E

16.0

2.8

FY17E

18.0

ROAA (%)

ROAE (%)

4.5

FY10

4.9

FY11

4.8

FY12

3.8

FY13

2.8

FY14

3.0

FY18E

Source: Company, MOSL

6 October 2015

Muthoot Finance

Exhibit 30: Comparative valuation

CMP

(INR)

Muthoot

MMFS

STF

BAF

CIFC*

SKSM*

163

238

945

5,488

642

425

MCap

(INRb)

EPS Growth (%)

-19.7

-2.1

24.2

21.7

136.0

-0.9

-3.7

17.4

11.7

23.8

12.1

30.9

-8.7

15.7

19.7

9.7

P/E (x)

8.2

19.8

15.2

23.4

18.5

21.4

30.9

17.5

6.9

15.7

13.0

19.9

14.5

14.8

26.7

14.5

1.3

2.4

2.3

5.4

3.5

5.1

4.3

2.8

P/BV (x)

1.2

2.2

2.1

3.8

2.8

4.1

4.9

2.5

1.0

2.0

1.8

3.3

2.4

3.3

4.3

2.2

2.6

2.0

3.1

2.0

5.2

2.3

3.2

RoA (%)

2.7

1.9

2.1

3.1

2.1

4.7

2.8

3.5

RoE (%)

2.8 14.3 14.7 16.0

2.2 15.5 11.5 13.2

2.3 14.1 14.1 14.9

2.8 20.4 19.8 17.9

2.3 17.9 16.3 17.4

4.9 24.9 21.4 24.7

2.9 16.9 16.9 17.2

3.6 15.8 15.3 15.9

Source: MOSL

FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16EFY17E

-6.3 -18.4

25.9 16.1

18.5 20.8

17.4 28.9

27.6 20.8

44.5 28.0

15.8 28.2

20.7 20.2

64.9

134.1

214.4

276.6

100.3

53.9

162.3

117.8

Sundaram Fin*

1,461

Shriram City

1,787

Union*

* Consensus estimates

Exhibit 31: PE ratio

3.9

7.9

7.4

P/E (x)

Avg(x)

Peak(x)

Min(x)

12.2

Exhibit 32: P/B ratio

2.6

1.8

1.0

0.2

0.6

P/B (x)

Avg(x)

Peak(x)

2.2

Min(x)

1.4

1.1

Source: Bloomberg, MOSL

6 October 2015

Muthoot Finance

Risks

Regulatory risks:

While RBI has softened its stance on gold loan NBFCs, any adverse

change in regulations can impact the business growth and profitability

Volatility in gold prices and sharp variance between Indian and international

prices:

The price differential between domestic and international market increased

to 17% from 2% at the beginning of 2013. With the current account deficit coming

under control, there have been media reports that the government is considering to

roll back the duty hike on gold. If the hike is rolled back and currency appreciation

leads to 5-10% reduction in gold prices, it could again create fears of asset quality

issues.

Competition:

Increased competition from both banks and non-banks could lead to

lower lending yields and growth, thus impacting profitability.

Liquidity risk:

A tight liquidity situation could impact the company’s funding costs

and ability to grow, as it is primarily funded through bank loans.

6 October 2015

Muthoot Finance

Annexure

Gold loan penetration remains low; niche expertise will

be a growth enabler

Low penetration, large addressable market provide growth headroom



Current outstanding stock of gold in India stands at INR60t, while the gold loan market

stands at INR1.6t.

Even if 20% of the gold can be monetized, the organized gold loan market can grow to

INR8.8t.

Penetration levels in the organized gold loan market stand below 20%, while the

addressable market remains large.

Gold loan NBFCs are better placed to tap the opportunity due to product-/customer-

centric business model.

Indian households possess

~20,000tn of gold

worth INR60t

Gold has religious and cultural significance in India, and has acquired the most

popular form of savings for households (especially with rural population). Besides

the religious and cultural significance, the high demand for gold has historically

stemmed from low penetration of banking facilities, laws of inheritance and the

Yellow Metal being the best bet against inflation.

India is the biggest importer of gold and as per estimates of the World Gold Council,

Indian households possess ~20,000tn of gold worth INR60t. However, monetization

of gold remains very low in the country. Despite a surge in the gold loan market

(during 2008-12), the combined penetration levels for all organized players (banks

and NBFCs) remain low at ~18% of the potential gold loan market in India (our

estimates based on the assumption that ~20% of the country’s gold holding can be

monetized). Given the low penetration levels, headroom for growth remains high.

Also, with 65% of India’s gold being held by the rural population (according to Rao

committee) with limited banking facilities, the opportunity could be sizeable.

Exhibit 34: Gold loan share of banks and NBFCs

Bank

13.2

12.2

20.3

NBFCs

27.5

27.7

Despite a sharp surge in

gold loan market, the

combined penetration

levels for all organized

players (banks and NBFCs)

remain low at 18% of the

potential gold loan market

in India

Exhibit 33: Organized gold loan market in India stands at

INR1.6t

Total gold loan(INRb)

1550

850

540

200

FY08

320

86.8

87.8

79.7

72.5

72.3

FY09

FY10

FY11

FY12

FY08

FY09

FY10

FY11

FY12

Source: KUB Rao committee report

Exhibit 35: Loan against gold: Opportunity size

Penetration of gold loans

remains low at ~18% and

provides headroom for

growth in ensuing years

Accumulated gold stock (tonnes as per Rao committee report)

20,000

Gold rate (INR per 10 gm)

29,600

Value of gold holding in India (INR b)

59,000

Amount of gold that could be potentially pledged (tonnes, assuming 20%)

11,800

Target market size for gold financiers (INR t, assuming 75% LTVs)

8,850

Current outstanding loans (INR b, Rao report)

1,600

Penetration of gold loans (% of total potential)

Source: MOSL, Rao committee report

6 October 2015

Muthoot Finance

USP of specialized NBFCs

Specialized NBFCs, with their vast experience and singular focus on gold loans

segment, have developed a deep understanding of key customer segments and

business dynamics and acquired niche capabilities to cater to target customer

segment’s requirements.

Single-product focus enables customer-centric business model

Single product focus allows

companies to structure

products better than banks

Gold NBFCs have a clear focus on gold loans, which enables them to have a

customer-centric business model and results in better and quicker customer service.

The single product focus also allows them to better structure products vis-a-vis

banks. Features such as no deduction of ‘advance interest’, top-up loans in case of

material gold price rise, partial repayment and de-pledging of jewelry, and easy

renewal bear testimony to their business model. On the contrary, bank employees

have multiple responsibilities in besides their primary role—cross-selling, reporting

and compliance being the major ones.

Expertise in cash-handling capabilities

Specialized NBFCs have developed high cash-handling capabilities as most

transactions are in cash, while banks are restricted by regulations in cash dealings.

Minimal documentation

Specialized NBFCs operate with minimal KYC norms and check for only basic

documents such as identity proof, while banks insist on full compliance to KYC

norms (including proof of identity, address proof, signature proof and photographs).

Close-to-customer model with vast branch network

MUTH’s branch network has grown almost 4x—from 985 branches at end-FY09 to

over 4,220 branches as in 3QFY14. However, before the newly-opened branches

could grow their AUMs to breakeven levels, fund availability became a huge

constraint as RBI clamped down on gold NBFCs’ business practices in March 2012.

The companies responded by cutting down advertising expenses to control costs.

However, sharp AUM slowdown brought the negative impact of operating leverage

and resulted in rising cost-to-AUM ratio for gold NBFCs post March 2012. With the

regulatory environment easing, business will be back on track and we expect higher

utilization of the existing branch network and manpower.

Fast turnaround time, strong appraisal and valuation expertise

While the turnaround time

for NBFCs is ~15 minutes for

existing customers and less

than an hour for new

customers; the same can

take t2-4 days for a bank

Due to single product focus, all gold NBFCs’ branch employees are well versed with

the appraisal methodologies. Hence, the turnaround time for a new customer is less

than an hour and ~15 minutes for a repeat customer. For banks, the turnaround

time varies as per the facilities in the branch. While most South-based state-owned

banks have a quick turnaround time as they have a valuation expert in the branch

premises, some private banks do not have the requisite infrastructure in all the

branches (few designated branches with valuation experts). Hence, the turnaround

time varies from a few hours to 2-4 days.

6 October 2015

Muthoot Finance

Low-cost structures and flexible operations

Gold NBFCs operate with a very lean cost structure compared with banks, which

have to develop large infrastructure for retail liabilities/assets. Bank branches that

offer gold loans have to either hire a full-time valuation expert or tie up with a local

valuation expert, thus creating a trade-off between employee cost and turnaround

time. Also, most employees in the specialized gold lending have adequate training to

value gold. Space constraints would also restrict many urban bank branches from

creating a strong room, which is an essential requirement for gold loans.

Lack of focus area for banks—gold loans form a small portion of loan book

Given the small-ticket size of gold loans and multiple retail asset products that banks

focus on, it is unlikely that gold loans can form a sizeable chunk of a bank’s total loan

book in the near future. Barring South-based private banks, for whom gold loans

account for 10-20% of the total loan book, gold loans constitute a small proportion

of the retail loan book for most large banks; this is despite posting high double-digit

growth over the past two years.

Other Businesses

Housing Finance: Muthoot HomeFin

MUTH has entered the housing finance business with Muthoot Homefin and will

invest INR500m in the company. The housing finance will operate as a subsidiary of

MUTH.

Muthoot Homefin will operate from separate branches where it will have a hub and

spoke model; however, MUTH will leverage its existing branches to generate leads

for the new company.

Muthoot Homefin offers home loans and loans against property and has a loan book

of INR100m.

Exhibit 36: Loan products from Muthoot Homefin

Home Loan

LTV

Tkt Size

Tenure

Interest

up to 80%

INR0.1m to INR50m

up to 30 years

>9.9%

LAP

INR1m to INR50m

up to 15 years

Source: Company, MOSL

Business correspondent for Yes Bank

Since 3QFY15, MUTH has been acting as a business correspondent (BC) for Yes Bank.

Under this arrangement, the company would offer services of Yes Bank through its

branches. MUTH would initially start with domestic remittances and later distribute

other products from Yes Bank.

The company would earn fee income from offering these services and, thus, would

improve its operating leverage as it does not need to make any additional

investments.

6 October 2015

Muthoot Finance

White Label ATMs

Muthoot Finance operates ~200 White Label ATMs (WLA) under the brand of

Muthoot ATM. WLAs are non-bank ATMs operated by private companies.

Customers of any bank can use these machines to access their accounts for a fee.

Most of the ATM machines installed are on lease and are primarily installed in

existing branches; thus MUTH has made no large capital investments in the

business. MUTH would earn an interchange fee when an ATM card holder uses the

company’s ATM machine to transact. The company plans to leverage its existing

branch network to expand its ATM network; the business, however, is yet to make

any significant contribution to company’s books.

Lending against gold in Sri Lanka

MUTH has acquired a controlling stake (51%) in a Sri Lanka-listed company Asia

Asset Finance, which would operate as a subsidiary of MUTH. MUTH would leverage

its expertise to expand and grow the gold loan portfolio Asia Asset Finance.

6 October 2015

Muthoot Finance

Company description: Flagship Co. of a diversified group

Kerala-headquartered Muthoot Finance is a non-deposit taking NBFC and the

flagship company of “The Muthoot Group”. Muthoot Finance has a long and

established track record and has been in the lending against gold business for the

last 70 years, whenh Mr M George Muthoot founded a gold loan business in 1939.

Muthoot Finance is the largest gold financing NBFC in India, with AUM of INR234b as

of FY15. MUTH’s gold loan portfolio comprises ~5.5m loan accounts in India, which

are serviced through 4,245 branches across 26 states and union territories. Apart

from the gold loan business, it provides money transfer services, white label ATMs,

collection agency services and has recently ventured into affordable housing

finance. It also operates three windmills in Tamil Nadu. However, its is concentrated

in the South—~65% of the branches and 57% of the total loans concentrated in

Kerala, Andhra Pradesh, Tamil Nadu and Karnataka.

Exhibit 37:

Management

Flow chart

Source: Company, MOSL

Management details

Promoters have ~75% stake in the company. Mr M. G. George Muthoot, Mr George

Thomas Muthoot, Mr George Jacob Muthoot and Mr George Alexander Muthoot

collectively manage the company under the brand. The senior management of

MUTH comprises professionals who have significant experience in the financial

services industry.

6 October 2015

Muthoot Finance

Exhibit 38: Management profile

Name

Mr M G George Muthoot

Mr George Thomas Muthoot

Mr George Jacob Muthoot

Designation

Chairman

Whole-Time Director

Profile

Mechanical engineering from Manipal University. He

became the Chairman of Muthoot Group in February 1993

Over 30 years of experience in managing businesses

operating in the field of financial services

Civil engineering from Manipal University. He is a member

of the Trivandrum Management Association and the

Confederation of Real Estate Developers Association of

India (Trivandrum).

Chartered Accountant and has served as the Chairman of

the Kerala Non banking Finance Companies Welfare

Association from 2004 to 2007

Bachelors of Science degree in Agriculture from Kerala

University and has been a banker with over 36 years of

experience in commercial banking. He joined Muthoot in

2005

Chartered Accountant and has over 15 years of experience

in the industry; joined the company in August 2001

Source: Company, MOSL

Ms George Alexander Muthoot

Managing Director

Mr K P Padmakumar

Executive Director

Mr Oommen K Mammen

Chief Financial Officer

Exhibit 39: Statewise branch network

Source: Company, MOSL

6 October 2015

Muthoot Finance

Financials and valuations

INCOME STATEMENT

Y/E MARCH

Interest Income

Interest Expense

Net Interest Income (Incl Sec.)

Change (%)

Other income

Net Income

Change (%)

Operating Expenses

Pre Provision Profits

Change (%)

Provisions (excl tax)

PBT

Tax

Tax Rate (%)

Profits for Equity SH

Change (%)

Proposed Dividend

BALANCE SHEET

Y/E MARCH

Equity Share Capital

Reserves & Surplus

Net worth

Borrowings

Change (%)

Other liabilities

Change (%)

Total Liabilities

Loans

Change (%)

Investments

Net Fixed Assets

Other assets

Total Assets

E: MOSL Estimates

2011

22,841

10,383

12,458

109.5

318

12,776

107.8

4,822

7,954

128.4

342

7,612

2,670

35.1

4,942

117.1

2012

45,158

23,699

21,459

72.3

333

21,792

70.6

8,059

13,732

72.7

420

13,312

4,392

33.0

8,920

80.5

1,487

2013

53,360

28,194

25,166

17.3

511

25,677

17.8

9,667

16,010

16.6

895

15,114

5,072

33.6

10,042

12.6

1,673

2014

48,920

26,260

22,661

-10.0

554

23,214

-9.6

10,841

12,374

-22.7

438

11,936

4,135

34.6

7,801

-22.3

2,230

2015

42,623

21,064

21,559

-4.9

624

22,183

-4.4

11,533

10,650

-13.9

371

10,279

3,573

34.8

6,705

-14.0

2,410

2016E

46,477

21,945

24,532

13.8

664

25,196

13.6

12,743

12,453

16.9

523

11,930

4,056

34.0

7,874

17.4

2,362

2017E

53,386

25,093

28,293

15.3

704

28,997

15.1

14,088

14,909

19.7

634

14,275

4,853

34.0

9,421

19.7

2,826

(INR Million)

2018E

63,050

29,521

33,530

18.5

744

34,273

18.2

15,583

18,691

25.4

765

17,926

6,095

34.0

11,831

25.6

3,549

(INR Million)

2018E

3,980

65,758

69,738

322,044

20.0

34,214

15.0

425,996

380,012

20.0

754

3,516

41,714

425,996

2011

3,202

10,142

13,344

119,340

126.1

4,526

-4.1

137,210

117,961

115.2

1,886

17,288

137,210

2012

3,717

25,540

29,257

193,764

62.4

10,701

136.4

233,722

214,699

82.0

975

2,682

15,366

233,722

2013

3,717

33,639

37,356

240,807

24.3

16,000

49.5

294,163

265,176

23.5

825

3,030

25,131

294,163

2014

3,717

38,929

42,646

194,776

-19.1

18,517

15.7

255,939

219,964

-17.0

354

3,270

32,351

255,939

2015

3,980

46,855

50,835

194,361

-0.2

22,496

21.5

267,693

235,412

7.0

454

2,642

29,185

267,693

2016E

3,980

51,965

55,945

223,642

15.1

25,871

15.0

305,458

268,370

14.0

554

2,906

33,628

305,458

2017E

3,980

58,080

62,060

268,370

20.0

29,752

15.0

360,181

316,677

18.0

654

3,196

39,654

360,181

6 October 2015

Muthoot Finance

Financials and valuations

RATIOS

Y/E MARCH

Spreads Analysis (%)

Avg Yield on loans

Avg Cost of funds

Spreads on loans

NIMs on AUM

Profitability Ratios (%)

RoE

RoA

RoA on AUM

Cost to Income

Empl. Cost/Op. Exps.

Asset-Liability Profile (%)

Net NPAs to Adv.

Debt/Equity (x)

Average leverage

CAR

Valuations

Book Value (INR)

Price-BV (x)

Adjusted BV (INR)

Price-ABV (x)

EPS (INR)

EPS Growth (%)

Price-Earnings (x)

Dividend

Dividend Yield (%)

E: MOSL Estimates

2011

26.7

12.1

14.6

10.7

2012

27.4

15.1

12.2

10.6

2013

22.4

13.0

9.4

9.9

2014

20.3

12.1

8.2

9.4

2015

18.8

10.8

8.0

9.5

2016E

18.5

10.5

8.0

9.8

2017E

18.3

10.2

8.1

9.7

2018E

18.1

10.0

8.1

9.6

51.5

4.9

4.2

37.7

45.8

4.8

0.3

8.9

9.0

15.8

41.9

4.8

4.4

37.0

51.4

4.3

0.5

6.6

7.3

18.3

30.2

3.8

3.9

37.6

56.4

3.7

1.7

6.4

6.5

19.6

19.5

2.8

3.2

46.7

54.6

3.9

1.6

4.6

5.4

24.7

14.3

2.6

3.0

52.0

54.7

4.4

1.9

3.8

4.2

24.8

14.7

2.7

3.1

50.6

55.4

4.4

1.8

4.0

3.9

0.0

16.0

2.8

3.2

48.6

56.1

4.2

1.6

4.3

4.2

0.0

18.0

3.0

3.4

45.5

56.8

4.0

1.5

4.6

4.5

0.0

41.7

3.9

41.2

4.0

15.4

103.3

10.6

0.0

78.7

2.1

77.6

2.1

24.0

55.5

6.8

2.5

100.5

1.6

96.2

1.7

27.0

12.6

6.0

4.5

2.8

114.7

1.4

111.5

1.5

21.0

-22.3

7.8

3.7

127.7

1.3

123.9

1.3

16.8

-19.7

9.7

3.7

140.6

1.2

136.3

1.2

19.8

17.4

8.2

5.9

3.6

155.9

1.0

151.4

1.1

23.7

19.7

6.9

7.1

4.4

175.2

0.9

170.1

1.0

29.7

25.6

5.5

8.9

5.5

6 October 2015

REPORT GALLERY

RECENT INITIATING COVERAGE REPORTS

Muthoot Finance

NOTES

6 October 2015

Muthoot Finance

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