Gold finance stocks: Recent rally increases risk; wait for a better entry

Rally factors in strong performance of Muthoot and Manappuram

Even as a majority of the banking and financial services sector companies, including mortgage lenders, auto loan providers as well as banks, have been struggling in the wake of the Covid-19 pandemic, gold financiers have been in a sweet spot.

The stocks of Muthoot Finance and Manappuram Finance have gained between 100 per cent and 131 per cent since their March lows, outperforming the 28-per cent rise in the Nifty Financial Services Index during this period.

The strong performance of their core gold loan book (65-95 per cent of consolidated assets under management or AUM) is a key reason for the improved sentiment. Led by 21-31 per cent increase in the gold loan book, their profit before tax was up 30-38 per cent year-on-year in Q4.

The core business is expected to continue supporting the overall financials. Firm gold prices and strong demand for gold loans are among the key drivers for the loan book. Asset quality also remains comfortable, supported by the highly liquid collateral (gold).

Even as the earnings outlook remains good, investors need to be aware of the downside risks, following the recent rally.

 

 

For one, these stocks are now trading at, or near, their lifetime high valuations of 2-3.4s their FY21 estimated book. Siji Philip, senior research analyst-BFSI at Axis Securities, says: “We believe the current valuations of the gold finance companies factor in their strong growth and earnings outlook, while risk aversion by banks and other non-banking financial companies (NBFCs) could offer some upsides even from the current levels.”

Once the current situation improves, gold finance stocks could reverse some of the gains, as banks and other NBFCs would see strong inflows.

Fundamentally, too, there are some concerns over the asset quality of non-gold segments like microfinance and auto loans, but mainly for Manappuram, which has 30-35 per cent exposure to these segments. For Muthoot, this figure is just 5 per cent.

Manappuram’s management, during its March quarter (Q4), had indicated some near-term pressure for its microfinance and auto loan segments. Although, an industry expert expects the collections for microfinance to have improved recently, the jury is still out on this.

Alpesh Mehta, analyst at Motilal Oswal, says, “While the strong growth prospects in the current environment would fare better for the gold finance stocks, the recent rally leaves limited room for any negative factor, which one needs to be careful about.”

The domestic brokerage has a ‘neutral’ rating for Muthoot, while Manappuram is not under its coverage. A key risk is gold prices falling sharply towards or below the loan value.

Overall, investors should await a correction for a better entry into the stocks.