Tuesday, March 11, 2014

Muthoot Finance - incredibly cheap!


India is voracious consumer of gold and thus the world's largest lender against gold is in India. This company is like a large professional bank that has a very liquid and easily measurable collateral. NPAs thus are irrelevant. Moat is not super great but still good. Price seems cheap even though the stock is up 65% from just 2 months ago!

1. How big is the moat?

B+ Category.

  • Brand: While searching for a loan typically you go for the cheapest - the only factor here is that these are gold loans against the family jewelry. For which you might consider a known name & trust. The fact that Muthoot claims to be around since 1887 is a big factor.
  • Distribution: This is a huge competitive advantage and there is room for growth in the North, east and west as the south already has a lot of reach.
  • Vendors & employees: There doesn't seem to be much that cannot be replicated here.
  • Resilience to downturns: I would expect more loans to be taken out against gold and jewelry during downturns so economic downturns does not seem to be a huge risk.

2. What are the risks?

  • Revenue growth: Overall credit access is low so opportunities for growth are humongous. In fact the 5 year growth in revenues from FY 2008 to FY 2013 has been a whopping 14 times or 70% CAGR! That sounds too good to be true to me.
  • Collateral risk: Most banks suffer massive collateral risks in terms of loan to value (LTV) ratio risk due to fluctuation and the complexity of liquidating the collateral. For a gold loan lender 60% LTV statutory limit is very safe and liquidating the collateral is very simple relative to liquidating a real estate collateral. Recently the LTV has been increased to 75% - increasing the LTV is a double edged sword - increases risk but increases the ability of the company to lend.
  • Theft: Of collateral by various agencies is something I am worried about and the company ofcourse claims its a fool proof system but I find it hard to believe how this is managed across 4000+ branches.
  • >25% fall in the value of Gold in INR - is extremely unlikely as the insatiable appetite for India to consume gold is unlikely to abate. And inflation ensures that the value of Gold in INR is typically rising over longer periods. In case this does happen it could wipe out the company.

3. Financials

  • Capital adequacy ratio - is greater than 20%  - which is far better than for example HDFC bank (which is probably the best managed and most conservative bank in India).
  • If the claims about the gold backing each loan are correct the the NPAs probably dont matter but the gross NPAs are high at 1.99% - almost 2 times the HDFC Bank gross NPAs (~1% )
  • Return on Equity has been high - over 30%. Latest 9M ended Dec 2013 the annualized ROE is around 19% or so which is lower than earlier but still better than most banks. It is higher than all large banks other than HDFC in the country (which has an ROE of around 20.5%)
  • In short given the risk reward it might be better to buy Muthoot finance than bank stocks. Yes HDFC Bank is a better company probably but that trades at 94 times earnings versus Muthoot finance currently at 7.9 times earnings!
  • Dividend % of net income - around 19.3% which is a healthy percentage to payout and ensures that profits are shared with shareholders routinely.

4. Soft factors

  • Promoter shareholding: Promoter family owns over 80% of the company.
  • FIIs own 10%+ which will lead to large volatility but that is a good thing for value investors.
  • Matrix partners has a large position and own 2%+ of the company

5. Pricing

  • If we take the reduced earnings of the 9M ended Dec 2013 and annualize them we get 798 crores of PAT for FY 2014. Today the stock trades at around 8 times that as total value which seems cheap to own
  • Price to book - Relative to the gold loan industry the price to book is expensive at 1.54 times book (Dec 2013 book value) as most gold loan lenders trade under 1 times book but that is because this company's margins are higher and its ability to lend while keeping the capital adequacy ratio in control is high. Relative to high quality banks like Axis or HDFC the price book is cheap (both Axis and HDFC trade at over 1.95 times book)
  • Bottom line I would have this stock in my portfolio at 172 INR/share