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Muthoot Finance Q2: The best is certainly behind

Pressure of competition from banks is discernible.


    • Gold loan growth decelerating, non-gold picking up mostly on lower base
    • Margin under pressure, further contraction possible
    • Competitive intensity from banks unlikely to go away
    • Reported asset quality stable thanks to large sale to ARC
    • Raises questions about the quality of incremental borrowers although the business is secured
    • Ambitious growth plans for non-gold, but not meaningful except for micro-finance
    • We see declining return ratios and moderate earnings growth

Muthoot Finance

(CMP: Rs 1273 Market Cap: Rs 51,115 crore, Rating: Equal-weight) had reported strong growth in its core gold loan business in the past two quarters contrary to our apprehensions about competitive pressure impacting the business. However, the effect of competitive pressure was evident in Q2 with moderation in loan growth, pressure on operating margin, and a deterioration in asset quality although we acknowledge that the business is secured. Although the company’s focus is on growing the non-gold business, except for micro finance, the rest are insignificant. Muthoot will be a company with modest earnings growth to be added only on meaningful correction.

Multiple headwinds in Q2

Gold loan growth decelerating

Muthoot Finance’s core gold loan business, which is over 85 percent of the total book, saw a modest 2 percent sequential growth although the year-on-year (YoY) growth still looks decent on a modest base. The overall loan growth of 21 percent YoY and over 7 percent sequentially was driven by the robust growth in the non-gold businesses.

We see rising competitive intensity as a challenge for a large gold loan NBFC like Muthoot. Banks, with their funding cost advantage, are getting aggressive in this area. With rising concerns over unsecured lending, gold loan, which is totally secured yet high yielding, is a great product for banks and we do not see the competitive intensity waning as they now have the reach (tie-up with Fintechs and smaller NBFCs).

Margin compression – a trend unlikely to reverse

The company saw a sequential decline in lending yields and an increase in borrowing cost resulting in a compression in spread and net interest margin. While the cost of funding is a function of systemic interest rates and, hence, unlikely to reverse in a hurry, the competitive intensity will not allow Muthoot to chase higher lending yields, resulting in a compression in interest margin. Interest spread, which was upwards of 10 percent, is now guided to settle in the 9-10 percent band.

What do we read from the spike in Stage 3 assets

While we do recognise that gold lending is completely secured, the spike in reported Stage 3 assets cannot be ignored. The reported Stage 3 assets that soared to 4.26 percent in Q1, moderated a bit in Q2 thanks to Rs 700 crore of Stage 3 asset sale to ARC (asset reconstruction company).  With a loan-to-value of 60 percent, the principal and overdue interest is covered and hence Muthoot prefers to give time to struggling borrowers rather than auction the jewellery immediately. While this is a great strategy to gain loyalty, the spike in bad assets and the need to sell to ARC to report a lower Stage 3 figure point to incrementally deteriorating borrower profile as typically in a gold loan product the credit quality of the borrower is not scrutinised. We see this as an early warning as this trend points to better quality borrowers gravitating to banks.


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