Change in regulations and rising competition mar the company?s growth prospects

BofA Merrill Lynch

We cut Manappuram General Finance (MGFL) two notches to an Underperform (vs Buy) and price objective to R20 (from R48) driven by (i) a steep, around 30% EPS cut for both FY13/14 due to higher than estimated under recoveries from auctions in Q4 and the fact that (ii) guidance has been inconsistent and the risk to future earnings is high, as the company still needs to auction +R9-10 billion of gold loans in Q1FY14, which can be impacted by gold prices. Hence, the stock may de-rate (trades at 0.8x FY14 book) to around 0.6x one-year forward (target PB) given rising concern on gold prices and weaker outlook on demand due to higher competition and tighter regulatory norms and structural decline in RoEs (returns on equity) to around 12.5/15% (FY13/14) vs. historical average of +25%.

Under recoveries to be much higher than estimated earlier: MGFL had disbursed gold loans aggregating R15 billion at an aggressive LTV (loan to value) ratio of +80-90% between Nov?11 to Jan?12. Many of these loans are now running into problems since (a) gold prices are down +4-5%, eroding the security completely and (b) with RBI changing the LTV ratio to 60% in Feb 12, the roll over of these loans is not possible.

EPS cut by around 30% reflects est. Q4 loss on under recoveries: We have cut our FY13/14 EPS (earnings per share) estimates by around 30% to reflect the higher then expected under recoveries. The total receivable on these set of loans including interest accrued is now R20 billion. Of these, the company will not recognise around R 900 million as income in Q4 and also will book a loss of +R1.5-1.6 billion as under-recovery on fall in gold prices. Hence, we now expect MGFL to report a Q4FY13 loss (vs. earlier estimate of a profit). Moreover, based on MGFL conference call takeaways, growth remains is a challenge driven by stricter RBI rules/rising competition from banks.

Price objective basis & risk: We set our PO (price objective) at R20/share for MGFL. MGFL is the second-largest NBFC, with a market share of +7-8% in the organised segment. Change in regulations and rising competition has affected MGFLs growth prospects. While valuation comfort is high and capital adequacy remains amongst the best, we rate MGFL, as Underperform on near-term growth challenges and lack of re-rating triggers. MGFLs inability to scale up in a timely manner its risk management systems in line with expanding business could potentially lead to asset-quality issues.