Buy Muthoot Finance; target Rs 197: Hedge Equities

“Muthoot Finance Limted (MFL) is a “systematically important non-deposit taking NBFC” that is involved in the business of providing loans against gold and is today, considered to be the largest company in India (in terms of loan portfolio, with a gold loan portfolio of Rs.22694 crores provided to over 5.5 million accounts) to be offering this service. It is the flagship company of the Kerala based “Muthoot Group”. MFL has an operating history of over seven decades having first started the gold loan business in 1939. However it was only in 2001 that the company secured an NBFC license from the RBI. In addition to the gold loan business, MFL also provides money transfer services through their various branches by acting as sub-agents of various registered money transfer agencies. Recently MFL has also got into the collection agency services. In addition to all of that the company also operates three windmills in the state of Tamil Nadu. Currently MFL has a branch network of 3480 brances (at the end of 9MFY12) with 64% of the branches located in the Southern territories of the country. At the end of FY11 the company had an employee strength of 16668 employees.

Muthoot Finance Limited (MFL) is a non-deposit taking NBFC primarily involved in financing personal and business loans secured by gold as collateral. The company has been in this business for over seven decades and today enjoys market leadership in the gold market estimated to be around 19.5%. The company’s business model is well poised to flourish in an era where people’s appetite for gold (and the ensuing sentimentality associated with possessing the metal) is increasing by the day. The Indian NBFC sector plays a very important role in financial intermediation in the country, accounting for around 9-10% of the total financial assets in the system and their fundamental importance to the country’s development is set to continue. However going forward the situation is likely to be a lot more challenging as the NBFC sector seeks to grapple with the twin issues of diminishing competitive advantages (weaker barriers to entry) and greater regulatory pressures.

NBFCs have enjoyed tremendous competitive advantages relative to their banking peers for over a decade now (and perhaps even longer), and some of the integral reasons for this occurrence was because they were willing to put their money where their mouth was and seek to finance segments that the traditional banks were wary off. While the banks struggled to understand these risky markets which were predominantly based in rural areas and involved a target market that functioned on variable sources of income and lacked any banking habits, the NBFC players took the plunge and sought to develop their expertise in these segments. Despite facing initial struggles, the NBFC players have, with time, developed a solid understanding of their market and this have been able to realign and adjust their business models to cater to the market. With time, these NBFCs have also been able to develop niche characteristics and thereby solid competitive advantages relative to the banking class.

Aggressive investors are advised to buy the MFL stock at <Rs.149 levels as this is our weighted average buying range (50% weight on excess return on book value price and 50% weight on the 30% margin of safety DCF buying price) with a price target of Rs.197 (as this is our weighted average price target with 40% weights on both the DCF and PBV targets and a 20% weight on our PE target),” says Hedge Equities research report.

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