Gold loan stocks to feel the pinch from duty cut as margin of safety shrinks: Analysts

Over the past five years, rising gold prices have significantly benefited Muthoot Finance and Manappuram Finance

While jewellery stocks danced on reduced customs duty on gold to 6 percent from 15 percent, but shares of top gold loan issuers Manappuram Finance, Muthoot Finance - took a hit, plunging over 5 percent each after the Budget announcement. Analysts believe that this reduction in gold duties could lead to lower gold prices, which could negatively impact gold loan companies in the near term by diminishing their financial cushion or 'margin of safety.'

Deepak Jasani, head of retail research at HDFC Securities explained that if gold prices start to decline, gold financing companies might experience a reduction in their loan-to-value (LTV) ratios, making them less financially secure.

A lower LTV ratio means that the value of the gold used to secure loans is less compared to the total loans issued, thus reducing the companies' margin of safety.

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Jasani also highlighted that fewer people and businesses might take out new loans backed by gold since the value of the gold collateral would be lower. He advised investors to consider taking profits from related stocks given these potential impacts.

Analysts at InCred Equities shared similar concerns, noting that a decline in gold prices could lead to irregular repayments by borrowers if the value of their gold collateral falls below the loan amount.

Despite these concerns about LTV ratios, analysts at SBI Funds Management believe that gold financiers will navigate these challenges effectively in the medium term. They noted that the LTV ratios for gold financiers are in the low 60s and do not expect significant asset quality issues.

Muthoot, Manappuram Finance glitters on rising gold prices

Over the past five years, rising gold prices have significantly benefited Muthoot Finance and Manappuram Finance. Gold prices have nearly doubled to Rs 68,918 per 10 gram from Rs 34,943 per 10 gram, leading to increased lending by gold financiers and boosting gold loan assets under management (AUM) in recent quarters.

Muthoot Finance's gold loans grew at a compounded annual growth rate (CAGR) of 16 percent in 5 years, driven largely by a 14 percent CAGR in gold prices. In contrast, Manappuram Finance's gold loan portfolio expanded at modest 11 percent CAGR during the same period.

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As gold loans account for 96 percent of Muthoot Finance's standalone assets under management (AUM), compared to 51 percent of Manappuram Finance's consolidated AUM, it indicates that Muthoot Finance's loan book is more heavily reliant on gold price fluctuations. In contrast, Manappuram Finance's AUM is more diversified, including micro-financial institutions (26 percent of AUM), vehicle loans (10 percent of AUM), and home loans (4 percent of AUM) in addition to gold financing.

The way ahead

Looking ahead, market participants will closely monitor gold's performance in dollar terms, as it will influence local gold prices. Independent market expert Ambareesh Baliga believes that the recent fall in gold prices due to the government’s move is already reflected in the market, and future trends will be driven by other market forces.

Similarly, Gaurang Shah, Senior Vice-President at Geojit Financial Services, expects that the festive season and monsoon activity will impact gold prices and, consequently, the performance of gold financiers. Shah noted that, as global gold prices have not decreased significantly, a rebound in domestic gold prices is anticipated now that the domestic event is out of the way.

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