Initiate coverage on Muthoot Finance with an ‘outperfor’ rating and a 12-month target price of R290 per share, valuing the stock at 2.0x FY16e P/BV. At 1.3x FY16e P/BV and 8.4x P/E, the stock is our top pick in the NBFC sector.
Muthoot is India’s largest, niche gold finance company. We believe the gold finance segment is ripe for a turnaround as regulatory concerns have largely receded, international gold prices have fallen substantially, loan growth should revive with economic growth, and most of the asset quality pain is likely over. Muthoot, being the largest incumbent with 4,265 branches, R218 billion of loans and strong asset quality, is best positioned to benefit from the improving business sentiment. We expect 13% loan CAGR, higher NIMs and 16-19% RoE over FY15-17e.
Recent RBI guidelines for NBFCs had little changes for gold financing NBFCs, indicating a largely stable regulatory regime ahead. Post a prolonged period of decline, Muthoot’s loan book has grown modestly in Q2FY15 (up 2% q-o-q). We expect loan growth to pick up to 10-12% over the next 12-18 months.
NIMs (8.75% in FY14) are set to expand in the medium term. Operating leverage will also increase with a growing loan book, leading to lower cost-income ratios. We believe the worst of asset quality pain is over and credit costs should stabilise going forward.