Running a non-banking finance company (NBFC) is not an easy task. It is said that behind every successful NBFC there are hundreds that fail. Well, it’s also easy to understand as to why the failure rate is high; to begin with, the companies are leveraged 8-10 times, hence, the margin for error is very small and then, even if the management is prudent, new regulations, political interference or one-off event such as demonetisation can bring companies down on their knees or wipe out their capital completely. We have quite a few listed NBFCs which have faced near-death events but yet emerged stronger, and one such company is Manappuram Finance. Running a non-banking finance company (NBFC) is not an easy task. It is said that behind every successful NBFC there are hundreds that fail. Well, it’s also easy to understand as to why the failure rate is high. To begin with, the companies are leveraged 8-10 times and, hence, the margin for error is very small. Also, even if the management is prudent, new regulations, political interference or one-off event such as demonetisation can bring companies down on their knees. We have quite a few listed NBFCs which have faced near-death events but yet emerged stronger, and one such company is Manappuram Finance.
In the past five years, Manappuram has faced several headwinds, starting with tougher regulations and non-level playing field in the gold loan business and then the recent demonetisation. Both the events, though negative in the short term, have actually helped the company reduce its risk through diversification and strengthen its core business model. With a level-playing field in gold loan business and dwindling impact of demonetisation, I expect Manappuram to record decent 18-20% CAGR in both assets under management (AUM) and profitability over the next few years.
In small and mid-cap firms, ideally, it’s important for an investor, that the promoters hold reasonably high stakes. In the case of Manappuram, the promoter holds 34.45% stake. While we prefer promoter holding of 50% or more, there is comfort in this case, as the promoter increased his stake by around 1% in FY17. The CFO and one of the directors, too, increased their stake through market purchases. We see this as a big positive, as the ones running the company understand it better than anyone else.
It was during F12-FY15, the gold loan market went through a pincer with the annual growth rate slowing down to 4%. During this period, the market was hit by a series of adverse events, including stricter RBI regulations, funding constraints, exit of new entrants and declining gold prices. During this period, specialised gold loan NBFCs lost significant market share to public sector banks and the unorganised sector. The market share of these NBFCs fell from 36.5% in FY12 to 28.6% in FY14.
Amid this turbulent phase, specialised gold loan NBFCs focused and spent their resources in consolidating their operations, diversifying risks, improving productivity from existing branch network and managing/retaining employees. As a result, they regained some lost ground with their market share back at 31% by FY16. As far as Manappuram is concerned, post the FY12-FY14 period, it realigned its business model to de-risk itself from the volatility in gold prices. The company has made an attempt at delinking the gold business from gold prices with the introduction of shorter tenure (3-6 months) products against the earlier 12-month product and recalibration of loan to value (LTV) to link it to the product tenure. In short, lower LTV for a higher tenure product and vice-versa. Thus, with the above two changes, if the customer does not pay or close the loan, there is ample margin of safety for the company to recover the principal as well as the interest cost.
To prevent the over-concentration on gold loans, the company since FY15 also ventured into three new business segments – microfinance, housing loans and commercial vehicle loans. This new businesses have since done well with their contribution increasing from a dismal 0.1%, as percentage of AUM, in FY14 to 19% by the end of FY17 and 21.6% as of September 2017. With the launch of the new products, the consolidated AUM saw 18.7% CAGR, while net profit showed 49% CAGR by FY17. Higher growth in net profit was on account of positive operating leverage and expansion in net interest margin as the cost of borrowing fell.
The company’s asset profile had also started improving with GNPA reducing to 1% at the end of FY16 from 1.2% in FY14 and NNPA reducing to 0.7% from 1%. Demonetisation impacted the asset profile with GNPA increasing to 2.3% at the end of Q3FY17 but has since fallen to 1.2% as of Q2FY18. Hopefully, there should be a continuous improvement going forward as cash availability improves. The first two quarters of FY18 have been not so good for the company (higher provisions for bad debt and lower loan book on account of demonetisation). However, sequential improvement in profitability is likely on account of expected growth in loan book, lower provisioning and lower security charges. The company’s capital adequacy ratio continues to be high at 25%-plus against the regulatory requirement of 15% and with very low leverage of about 3x, there’s ample scope for the company to increase its asset base without going in for an equity dilution.
The sheen is showing
Given a stable regulatory regime and steps taken by the company, the gold loan business of Manappuram is again on the growth path with 10.9% CAGR expected in the AUM over FY14-FY17 against a decline of 29% over FY12-FY14. The general expectation is that growth in AUM will stabilise at around 13%-15% over the next couple of years.
As far as valuations are concerned, we find the stock reasonable with a price to book of 2.28x, trailing twelve-month P/E of 11.32x and a dividend yield of around 2%. Against such a backdrop, we believe Manappuram is ripe for a rerating.
Disclosure: The writer has a holding in Manappuram Finance and the stock has been recommended to clients as well.