Gold Financiers: Investors advised to book profit on these stocks

Risks are similar to loan against property; both are dependent on pricing strength and demand of the underlying assets

There aren’t many takers for stocks of non-banking finance companies (NBFCs), but Manappuram Finance and Muthoot Finance seem to be the outliers, with their stocks more than doubling from their March lows, as a result of an exponential rally in gold prices during this period.

Primary market price for gold may be firming up. However, for lenders, the auction rate or secondary market price is more critical. This is the price at which they liquidate the stock in case of defaults, and this price is often at a significant discount to primary market rates. In other words, gold financiers lend based on market price, but recovery depends on auction price. Abhinesh Vijayaraj of Spark Capital says that in a normal market scenario, auction prices are at least at a 15–20 per cent discount to ruling market price.

However, with fewer marriages and festivities, the discount has widened. “Discount is a function of demand and supply, and at present, supply is more than the demand, which is why the discount has increased,” says Prithviraj Kothari, national president, India Bullion and Jewellers Association. The ornamental market is the key segment buying gold from the auction place.

 

 

The disparity between lending and recovery prices explains why the Reserve Bank of India did not allow NBFCs to increase their loan-to-value to 90 per cent from 75 per cent, a leeway that was recently handed out to banks. With the exception of CSB Bank (30 per cent), gold loans at best account for 5 – 12 per cent of the overall portfolio of banks, whereas for gold financiers, it is nearly 100 per cent of their total portfolio.

Shrinkage in the gold stock is another risk often step-sided by the Street. Manappuram and Muthoot saw their physical gold tonnage reduce on a sequential basis. This not only indicates the inability of customers to repay, but also that the growth may be challenged. In a high cost of borrowing scenario (over 9 per cent), dipping into the stock of gold can result in an asset-liability management mismatch.

In other words, risks involved in gold financing are very similar to those involved in the loan against property business. Both are dependent on the pricing strength and demand of the underlying asset, and are vulnerable to their cyclicality. Diversification into a non-gold portfolio such as vehicle, microfinance, and home loans, where gold financiers may not be dominant players, unlike the gold loan segment, is also hurting asset quality. Under such circumstances, it may be appropriate for investors to book profit on these stocks, which has doubled from March lows.