Outlook improves for gold loan companies

Stabilising gold prices and a conducive regulatory environment are key catalysts

Shares of gold loan companies such as Muthoot Finance (Muthoot) and Manappuram Finance (Manappuram) have rallied six per cent and 10 per cent, respectively, in the past month. One reason for this rally is that these stocks were beaten down on concerns such as falling gold prices, stringent regulations and increased number of customer defaults. Improving management outlook on future growth, stabilising gold prices and re-alignment of business models to reduce vulnerability to sharp gold price fluctuations are other reasons behind this surge. Even after the recent rally, the stocks are trading at inexpensive valuations. At Friday's closing prices, Muthoot is trading at 1.3 times FY17 estimated adjusted book value, while Manappuram is trading at 0.8 times, lower than their historical average one-year forward price to book ratio of 1.4 times and 1.2 times, respectively. Despite the muted performance in first half of 2015-16, analysts remain positive on these companies with expectations of further gains. “We believe emerging certainty in AUM (asset under management) growth following customer acquisition push at branch level and stabilising gold price will lead to valuation re-rating of Muthoot Finance,” says Kunal Shah, analyst at Edelweiss Securities.

Digant Haria of Antique Stock Broking seconds this view. He believes both these companies enjoy healthy dividend yields and current valuations ignore the positive developments in these companies' gold loan business.

On an average, analysts are factoring in upsides of 33 per cent for Muthoot and 46 per cent for Manappuram from current levels. The higher upside in the latter is due to the fact it was hit the most from regulatory tightening as it had higher loan to value ratio. The management believes auctions (of gold deposited by defaulting customers) should reduce in the second half of this financial year and hence, it expects growth to pick up. Muthoot management, on the other hand, believe its lower average lending rates (21 per cent versus 23 per cent for peers) should aid credit growth going forward.

The competitive pressures in the gold loan space have also reduced with non-focused players closing down and banks adopting a cautious approach. All these augur well for pure-play gold financiers such as Muthoot and Manappuram.

Very little of gold jewellery owned by Indians is pledged for loans offering attractive long-term growth opportunity for gold lenders. Muthoot being a leader stands to gain the most from any increase in such a trend. While the government’s gold monetisation scheme has met with poor response, any favourable revisions in the same could eat away some of the incremental business away from gold financiers.