Manappuram General Finance & Leasing - Initiating Coverage 14Dec09

8/14/2019 Manappuram General Finance & Leasing - Initiating Coverage 14Dec09

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Error! Reference source not found. Initiating Coverage 14 December 2009

1RHH: Winner of LIPPER-STARMINE broker award for Earnings Estimates in Midcap Research 2008

Honourable Mention in Institutional Investor 2009

RHH Research is also available on Bloomberg FTIS and Thomson First Call

Ishank Kumar Abhishek Agarwal

(91-22) 6766 3467 (91-22) 6766 3466

[email protected] [email protected]

Initiating Coverage 14 December 2009

NBFC Positive

Profitability and return ratios*

(%) FY09 FY10E FY11E FY12E

Net interest margin 13.0 13.0 14.8 15.4

Cost/Inc Ratio 47.6 44.6 38.2 36.3

RONW 30.9 33.8 34.6 33.8

ROA 3.8 4.7 5.9 6.3

Gross NPA 1.9 0.9 0.6 0.4

Net NPA 1.1 0.5 0.3 0.2

Financial highlights*

(Rs mn) FY09 FY10E FY11E FY12E

NII 1,651 2,891 5,379 8,345

Growth (%) 95.1 75.2 86.0 55.1

PPP 909 1,654 3,384 5,386

Growth (%) 96.1 81.9 104.6 59.1

FDEPS (Rs) 27.7 34.3 59.0 94.1

Growth (%) 9.1 24.0 71.9 59.4

Manappuram General Finance & Leasing

Tapping into a golden opportunity

Manappuram General Finance & Leasing (MAGFIL) operates in the niche businessof lending against gold collateral, primarily to low-income customers. Its clientprofile and niche expertise support higher interest rates, resulting in best-in-classmargins of 1315% and an ROE of 3035%. MAGFILs ongoing expansion drivewill help it tap into the large section of Indians not considered bank-worthy, butwho own the gold assets necessary to secure small loans. We expect its AUM totriple to Rs 59bn by FY12 as its distribution network expands. With a model thatis scalable and highly profitable, we initiate coverage on MAGFIL with a Buy.

Loans backed by gold tailor-made for India: Access to affordable credit servicesby Indias low-income segment remains limited, as small-ticket loans entail higheroperating costs and a higher perceived risk. Lower income households are still

heavily dependent on moneylenders who charge exorbitant rates. Substitution ofthese loans with gold-based lending by NBFCs holds tremendous potential due tothe safety of gold as collateral and large accumulated gold stock among Indianshouseholds. MAGFIL is a key player in this segment with strong expertise andcredibility in loan disbursal and jewellery valuation, particularly in South India.

Robust AUM growth to continue: The Manappuram group (MAGFIL and sistercompany MAFIT) has reported strong business growth during FY06-FY09, withgold loan assets under management logging a 125% CAGR due to aggressivebranch expansion and easy availability of funds. The group has ramped up itsdistribution network from 291 branches in FY07 to 765 in H1FY10 and isexpected to double its presence in the next three years. We expect this expansion

drive to aid a 67% CAGR in AUM to Rs 59bn over FY09-FY12.Best-in-class NIMs of 1315%: With clients who have little recourse to bankcredit and short-term funding needs, MAGFIL earns a high yield on advances of2430%. At the same time, improved access to institutional funds supports easyavailability of capital at a rate of 1012%. As a result, MAGFIL reported NIMs of1315% over FY07-FY09, which we believe are sustainable given its high pricingpower. With stable margins, we expect NII to log a 72% CAGR over FY09-FY12.

Merits premium valuation: We believe that MAGFIL represents an opportunity toinvest in a highly profitable business model with strong growth potential. Weexpect the company to maintain an ROE of 3335% over the next three years,with a PAT CAGR of 93% over FY09-FY12. With its superior return ratios and

asset quality (delinquencies at only 0.2% of AUM in the gold segment), webelieve the stock should trade at a premium to other NBFCs. We initiatecoverage with a Buy rating and target price of Rs 682, based on 2.8x FY11E ABV.

CMP TARGET RATING RISK

Rs 573 Rs 682 BUY MEDIUM

BSE NSE BLOOMBERG

531213 NA MGFL IN

Company data

Market cap (Rs mn / US$ mn) 9,913/213

Outstanding equity shares (mn) 17.3

Free float (%) 55.2

Dividend yield (%) 0.7

52-week high/low (Rs) 689/97

3-month average daily volume 12,223

Stock performance

Returns (%) CMP 1-mth 3-mth 6-mth

MAGFIL 573 6.1 45.5 152.8

Sensex 17,119 1.6 5.6 12.3

Valuation matrix*

(x) FY09 FY10E FY11E FY12E

P/ABV @ CMP 6.6 4.7 2.4 1.8

P/ABV @ Target 7.8 5.6 2.8 2.1

P/E @ CMP 20.7 16.7 9.7 6.1

* MAFIT financials consolidated with MAGFIL


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Manappuram General Finance & Leasing Initiating Coverage 14 December 2009

2

Investment rationale

Niche expertise in a large, under-served market

Gold-backed lending represents a potential goldmine for non-banking financecompanies (NBFC) in India due to the anaemic penetration of bank credit among lower

income households and considerable accumulated gold stock in India. The informalsector (local moneylenders) continues to originate more than 25% of the loans amongthe low-income group, charging an exorbitant interest rate of 36% p.a. These can besubstituted by cheaper, gold-secured loans from NBFCs. In spite of rapid growth in thegold loan segment in the last three to four years, its penetration in India remains under1%. Manappuram General Finance & Leasing (MAGFIL), with longstanding expertise ingold loan financing, is well placed to capitalise on the latent market opportunities.

Loans against gold the key to servicing weaker segments

India is the largest consumer of gold due to the strong preference for gold jewelleryamong Indian households and its widespread use as a savings instrument. MAGFILestimates that accumulated gold stock in India exceeds 20,000tonnes or 10% of the

global stock. Only a small proportion of this stock is held by the Reserve Bank ofIndia (RBI).

In spite of rising gold prices, demand in India has held firm owing to the countrys strongeconomic growth and rising disposable incomes. In 2008, India remained the leadingconsumer of the precious metal and accounted for 23% of global gold jewellerydemand. As per industry estimates, South India is the largest market accounting for 40%of the countrys demand, followed by the western region at 25% and northern regionat 2025%.

A large proportion of the gold stock is held by rural India as gold is viewed as a secureand easily accessible savings vehicle, apart from its ornamental status. This gold stockcan be used as collateral for securing loans to meet financial and emergency needs.

NBFCs and other financial institutions will undoubtedly lend against gold due to thelower perceived risk of the collateral.

Fig 1 -India constitutes ~23% of world gold demand

0

180

360

540

720

900

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

0

5

10

15

20

25

30

Annual consumer demand of gold % of world demand (R)(tonnes) (%)

Source: Bloomberg

Immense scope for financing Indias

low-income segments via gold-secured

loans

Indians have a prodigious appetite for

gold jewellery

Rural India has large accumulated gold

stock can be used as loan collateral


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MAGFIL has carved a niche for itselfBased in Kerala, MAGFIL is a deposit-taking NBFC primarily engaged in providing loansagainst used gold jewellery. Its target customer base consists primarily of lower incomehouseholds and self-employed workers, who are largely excluded from the banking netdue to a lack of credit history and relatively small loan requirements. A bulk ofMAGFILs lending comprises small-ticket loans only 14% of FY09 disbursals were for

loans over Rs 100,000 with tenure of less than one year.

Over the years, the company has developed strong expertise in gold-backed loandisbursal and jewellery valuation. The average loan to value (LTV) of the loans disbursedis ~75%; however, a small proportion of disbursals are granted at an LTV of 90100%.With clients that have limited access to the banking system and emergency financialneeds, average contracted lending rates are generally high at 24%. The average yieldenjoyed by the company is ~200250bps higher than the average contracted rate due tothe shorter loan duration (average tenure of only three months). This has allowedMAGFIL to report best-in-class NIMs of 1315% on its loan portfolio and an ROE of30%-plus over the past three years.

Fig 2 -Ticket size of disbursements FY09

Rs 25,000 -

50,000

27.0%

Rs 50,000 -

1,00,000

19.0%

Rs 10,000 -

25,000

26.0%

< Rs 10,000

14.0%

> Rs

1,00,000

14.0%

Source: Company

Fig 3 -Loan outstanding by tenure H1FY1012-18

Month

8.2%

> 18 Month

0.3%

< 1 Month

22.5%

1-3 Month

26.7%

6-12 Month

16.4%

3-6 Month

25.9%

Source: Company

Fig 4 -Average LTV of loans outstanding H1FY10

< 70%

12.0%

70-80%

42.6%

90-100%

0.0%

80-90%

45.3%

Source: Company

Fig 5 -Loan outstanding by interest rate charged H1FY10

21 - 24%

9.4%

24 - 27%14.4%

18 - 21%

1.9%< 18%

7.9%> 30%

23.6%

27 - 30%

42.8%

Source: Company

MAGFIL specialises in providing small-

ticket loans against used gold jewellery


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Better positioned than banks in small loan segment

We believe that banks will find it difficult to compete in the smaller loan segment whereMAGFIL and other NBFCs are currently active. Key reasons for higher competitivenessare as follows:

Expertise in valuing household jewellery: MAGFIL has been providing loans againsthousehold jewellery for the last five decades and has developed strong expertise inthe valuation of gold assets.

Higher LTV: NBFCs typically provide an LTV of 80%-plus as against 60% by banks. Minimal documentation: Documentation required by NBFCs is typically less

comprehensive than that sought by banks. NBFCs work on referrals and knowledgeof local markets and require only basic documents such as address or identity proof,whereas banks insist on full compliance with KYC (know your customer) norms. Asthe targeted client segment is largely illiterate, lengthy documentation is notfavoured by them.

Lower processing time and higher rollover flexibility: With less documentation andpaperwork, NBFCs are able to disburse loans far faster than banks. MAGFILgenerally disburses loans within 15 minutes as against three to four days taken bybanks. It also provides a facility for rollover of loan repayment without any extraprocessing fee.

Interest rate ceiling imposed on banks: RBI norms mandate that banks must providesmall loans (up to a credit limit of Rs 200,000) at an interest rate not higher than thebenchmark prime lending rate (BPLR). Given the higher fixed cost involved inprocessing and disbursal of smaller loans (operating cost to assets can be in therange of 57% of total assets), lending to these segments proves unprofitable forbanks. As a result, banks prefer to participate in the gold loan through securitisationroute or to extend loans to gold-financing NBFCs.

but micro-finance institutions and other NBFCs could pose a threatWe believe that competition in the gold loan segment will intensify over the next fewyears as other NBFCs and micro-finance institutions are lured by the higher lending ratesand lower delinquencies in the segment. Micro-finance institutions are currently lendingat ~24% to a similar client base and already have a large distribution network andcustomer base in some states. Some NBFCs like Muthoot Finance and Shriram CityUnion Finance are already active in gold loan financing and are aggressively expandingtheir distribution networks.

Nonetheless, low penetration of the gold loan business suggests that theres ampleenough of the pie for everyone. MAGFIL estimates that gold loan penetration in India isless than 1%. Local moneylenders continue to originate more than 25% of the loansamong earners with an annual income of less than Rs 100,000, according to a 2007

survey by Invest India Income and Savings (discussed in greater detail on Pg 10). Theaverage interest rate on these loans is 36%, much higher than the 24% charged byNBFCs and micro-finance institutions.

Merger with MAFIT to strengthen presence and competitive edgeIn order to strengthen its position in the gold loan financing space, MAGFIL is in theprocess of merging its sister company, Manappuram Finance (Tamil Nadu) or MAFIT,with itself. MAFIT is a non-deposit-taking NBFC with a major presence in Tamil Nadu,which has been active in the gold financing business since 2003. Approvals for themerger have been obtained from the stock exchanges and market regulator; courtapproval is expected shortly. Post merger, MAGFIL will have a stronger balance sheetand distribution network. Our estimates factor in the successful merger between bothcompanies (henceforth, MAGFIL refers to the combined entity).

Swift loan disbursal with minimaldocumentation gives MAGFIL an edge

over banks

Moneylenders provide 25% of loans in

low-income segments, implying ample

scope for substitution by gold loans


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Aggressive expansion of branch networkOver the last three to four years, MAGFIL has rapidly scaled up its distribution networkin order to better explore the gold loan financing opportunity and to enhance its scaleand visibility vis--vis rivals. Its branch network has swelled from 291 in March 07 to765 at the end of September 09. Close to 90% of the new branches were opened in theSouth Indian states of Kerala, Andhra Pradesh, Karnataka and Tamil Nadu, as the

average gold stock and acceptability of gold loans is higher in the south. As on 30September 2009, Kerala housed ~35% of the companys branches whereas othersouthern states housed 53%.

The company plans to open 250 branches every year in order to take its network to tallyto more than 1,600 by FY13. With an established presence in South India, MAGFIL willnow focus on the western, northern and eastern regions and has plans to open morethan 50% of its new branches in these states.

Fig 6 -Distribution network

0

100

200

300

400

500

600

700800

900

FY07 FY08 FY09 H1FY10

Kera la Andhra Pradesh Karnataka Tamil Nadu Maharashtra Others(No.)

Source: Company

Branch expansion and higher productivity to drive AUMMAGFIL has witnessed strong growth momentum in the last three years, with assetsunder management (AUM) growing more than 12-fold from Rs 1.5bn in FY06 toRs 17.8bn at the end of H1FY10 a 100%-plus CAGR. This growth was driven by rapidexpansion of its distribution network, higher gold prices and better access to funds.

Fig 7 -Robust growth in AUM

1.5

5.4

7.8

12.5

17.8

96.095.6

89.587.4

80.7

0

4

8

12

16

20

FY06 FY07 FY08 FY09 H1FY10

50

60

70

80

90

100AUM % of Gold loans (R)(Rs bn) (%)

Source: Company

Fig 8 -Gold prices on the rise

500

660

820

980

1,140

1,300

Apr-06

Aug-06

Dec-06

Apr-07

Aug-07

Dec-07

Apr-08

Aug-08

Dec-08

Apr-09

Aug-09

Dec-09

(US$ /oz)

Source: Bloomberg

Expansion in branch network from 291

in March 07 to 765 at end Sep 09

Plans to have 1,600 branches by FY13,

diversifying away from South India

12-fold growth in AUM from FY06 to

Rs 17.8bn at end-H1FY10


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We believe that the strong growth momentum in AUM will continue over the next fewyears driven by the expanding distribution network and a steady ramp-up in productivityat newer branches. As shown in Figure 6, MAGFIL has opened ~70% of its currentbranch network in the last 30 months, where productivity is significantly lower than thatat its established centres. At the end of September 09, average loans outstanding perbranch totalled Rs 23mn. For branches opened in FY06, this figure doubles to ~Rs 50mn

while those launched before FY05 boast an average of ~Rs 90mn100mn.

Average loan productivity of branches in Kerala at the end of H1FY10 is low at Rs 18mn(as against Rs 23mn32mn for other southern states) due to a rapid expansion in branchnetwork in the last 30 months the companys Kerala footprint has tripled from 89branches in FY06 to 267 in H1FY10.

Fig 9 -Average loan outstanding per branch H1FY10

0

5

10

15

20

25

30

35

Kerala Andhra

Pradesh

Karnataka Ta mil Nadu Maharashtra Others

(Rs mn/Branch)

Source: Company

We expect outstanding loans per branch to improve by 7080% from the current level

in the next three years, which will pump up AUM. Currently, loans originated in SouthIndia constitute ~90% of MAGFILs total outstanding portfolio. However, with a majorityof its incremental branches being planned in northern, eastern and western India, weexpect the southern market share to climb down to 7580% by FY13.

Fig 10 -AUM state-wise FY09

Others

5%Maharashtra

6%Tamil Nadu

20%

Karnataka

17%Andhra

Pradesh

18%

Kerala

34%

Source: Company

Fig 11 -AUM state-wise H1FY10

Kerala

27%

Andhra

Pradesh

20%

Karnataka

23%

Tamil Nadu

20%

Maharashtra

5%

Others

5%

Source: Company

Kerala branches have tripled over FY06

to H1FY10 now set for operational

ramp up

New branches typically take a couple of

years to mature

Lending concentration in South India to

decline to 7580% in FY13


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Easy availability of funds fuels growth

Rapid growth in AUM was also aided by easy availability of funds from banks and otherfinancial institutions. The flow of credit to higher-rated NBFCs has improvedsignificantly in the last three to four years, with easier access to term loans, commercialpaper and securitisation. MAGFIL has therefore increasingly turned to banks and the

capital market to meet its funding needs. Borrowing from institutional sourcesconstitutes ~8082% in H1FY10, with securitisation constituting more than 35% of totalborrowings. Equipped with better access to equity capital, MAGFIL now plans to keep alarger proportion of loans on its books. It also intends to tap the commercial papermarket to lower its cost of funds from the current 1212.5% to 11% by FY12.

Fig 12 -Borrowing profile FY09

Bank loans

22.3%

Others

1.0% Retail

18.6%

Securitization

58.1%

Source: Company

Fig 13 -Borrowing profile H1FY10

Retail

19%

Bank loans

42%

Commercial

paper

3%

Securitization

36%

Source: Company

Raised equity of Rs 1.8bn in last two years to fund growthIn order to expand its distribution network and meet the regulatory requirements of itsfast-growing business, MAGFIL raised Rs 1.8bn in equity capital over 2007 and 2008.The issue comprised compulsorily convertible preference shares to four private equityinvestors and warrants to promoters. While all the preference shares have beenconverted into equity, warrants issued to promoters will be converted this fiscal.

At present, MAGFIL is adequately capitalised with a capital adequacy ratio (CAR) of~30% at the end of September 09 (as against the regulatory requirement of 15%).However, with its aggressive growth plans and targeted leverage of 7x tier-I capital, thecompany is likely to soon require a fresh infusion of equity. We are factoring in 20%equity dilution in FY11 at Rs 550/share.

Fig 14 -Equity capital raised to fund growthDate Investors Price (Rs) Amount raised (Rs mn)# Method of dilution

10 December, 2007 Hudson Equity Holdings 142.5 700 Compulsorily convertibleSequoia Capital preference shares

4 November 2008 Hudson Equity Holdings 166.6 708 Compulsorily convertible

Sequoia Capital preference shares

AA Development Capital

GHIOF Mauritius

4 November 2008 Promoters 166.6 372 Warrants

Source: Company #Amount raised includes capital raised in MAFIT

Banks are now more open to financing

well-managed NBFCs

Aggressive growth plans call for capital

infusion we factor in 20% equity

dilution in FY11


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Asset quality to improve as percentage of gold loans risesMAGFIL is currently running down its hypothecation loan portfolio where gross NPArose rapidly in FY08 and FY09 to 18% and 38% respectively. The proportion ofhypothecation loans has declined from 18% in FY06 to only 2% in H1FY10. At thesame time, the share of gold loans has increased from 81% to 96%. We expect it to riseto over 99% by FY12.

Asset quality in the gold loan segment remains healthy with gross NPA hovering in the0.20.3% range over FY06-FY09. However, higher slippages in the hypothecationsegment resulted in an increase in overall gross NPA from 0.6% in FY07 to 2.2% inFY08 and 1.9% in FY09. With a draw-down of this portfolio, we expect gross NPA todecline to 0.4% by FY12.

Fig 15 -Composition of assets

0

20

40

60

80

100

FY06 FY07 FY08 FY09 H1FY10

Gold Loan HP/Hypothecation Others(%)

Source: Company

Fig 16 -Composition of gross NPA

0

20

40

60

80

100

FY06 FY07 FY08 FY09

Gold Loan HP/Hypothecation Others(%)

Source: Company

Fig 17 -Asset quality set to improve

0.0

0.5

1.0

1.5

2.0

2.5

FY07 FY08 FY09 FY10E FY11E FY12E

75

80

85

90

95

100

Gross NPA Net NPA Gold loans in AUM (R)(%) (%)

Source: Company, RHH

Gross NPA in the gold loan segment is

low at 0.20.3%


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MAGFIL Right place, right time

Financial inclusion remains a distant dream in India. Although the banking sector hasflourished over the past ten years, the growth has been underpinned largely by higherincome households and corporate sector. Among earners with an annual income of lessthan Rs 50,000, only 34% of the urban population and 27% of the rural populace have

a bank account. Moreover, only 8 out of every 100 persons have a credit account withscheduled commercial banks (SCB). Factors like the absence of credit history, inabilityto meet documentation norms, and higher fixed costs per loan deter the banking sectorfrom servicing lower income groups. This gap in the services net can be bridged byniche players like MAGFIL.

Indias financial services sector has leapfrogged ahead

Over the past decade, Indias financial services sector has witnessed explosive growth.Gross bank credit has increased at a 25% CAGR over FY03-FY09 driven by strong GDPgrowth and rising aspirations of Indian households. Increasing prosperity, buoyantcapital markets and aggressive expansion of retail distribution networks by banking aswell as non-banking financial service companies have bolstered retail awareness and

participation in various financial products such as credit, equity and insurance.

but access is limited to higher earnersGrowth in Indias financial services sector has primarily been driven by higher incomehouseholds and corporates. In spite of several initiatives taken by the government andthe RBI over the last three or four decades, access to safe, easy and affordable financialservices by the poor (both in urban and rural areas) remains limited.

In order to enhance financial inclusion, the government has followed a strategy of rapidexpansion of scheduled commercial banks (post their nationalisation in 1969) andformation of special purpose institutions (such as regional rural banks and cooperativebanks) to provide loans to the agricultural and weaker segments. In a bid to encouragebanks to lend to these segments, the RBI has defined sectors such as agriculture and

small scale industries as priority sectors and mandated lending targets of 40% of netbank credit for domestic commercial banks and 32% for foreign banks to these sectors.However, the success of these efforts has been mixed.

Over 60% of Indias earning population has no bank account

As per a 2007 survey conducted by Invest India Market Solutions (IIMS), only 45% oftotal earners (defined as a person who is aged between 18 and 59 years and earningsome cash income) have bank accounts. Penetration of banks in the lower incomehouseholds is even weaker in both urban and rural areas. Among earners with an annualincome of less than Rs 50,000, only 34% of the urban population and 27% of the ruralpopulace have a savings account. The study also revealed that a large proportion ofagricultural and unskilled/semi-skilled wage labourers, micro-entrepreneurs and low-salaried workers are currently excluded from the banking system.

Fig 18 -Earners holding a bank accountAnnual Income Urban Rural Total

< Rs 50k 34.1 26.8 28.3

Rs 50 - 100k 75.5 71.2 73.0

Rs 100 - 200k 91.8 87.4 89.9

Rs 200 - 400k 95.5 93.6 94.9

> Rs 400k 98.0 96.3 97.6

Total 61.7 38.0 44.9

Source: IIMS, 2007; RBIs Report on Currency and Finance 2006-08

Most of Indias population still does not

have access to the banking system

Government efforts at financial

inclusion have met with mixed results

Only 27% of rural earners (


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Fig 19 -Annual income and bank account by occupation group

319,555

140,001

105,670

100,044

64,507

60,078

59,687

37,300

33,100

31,676

21,295

478,985Businessman

Self-employed pro fessionals

Government salaried workers

Private salaried workers

Shopkeeper

Part t ime earner

Self-employed in primary production

Other self employed workers

Street vendor

Own account worker

Wage labour - non-agriculture

Agricultural wage labour

Average Annual Income (Rs.)

90

86

68

67

50

49

45

39

25

25

14

95Businessman

Government salaried workers

Self-employed pro fessionals

Private salaried workers

Shopkeeper

Other self employed workers

Part t ime earner

Self-employed in primary production

Street vendor

Own account worker

Wage labour - non-agriculture

Agricultural wage labour

P ercent with Bank Acco unt

Source: IIMS, 2007; Prof. Raghuram Rajan committee report on financial reforms

Institutional credit out of reach for most

Availability of credit from banks and other institutional sources is even more limited. Asper data submitted to the RBI, only 8 out of every 100 persons have a credit accountwith scheduled commercial banks (SCBs) in 2007. As per the IIMS survey in 2007,informal sources remain the dominant source of funds for lower income households.About 35% of earners with annual income below Rs 50,000 rely on local moneylendersfor their credit needs. Even some of the higher income households are dependent onlocal moneylenders as banks fail to meet their emergency needs.

Fig 20 -Credit accounts with SCBs region-wise (per 100 persons)Rural Urban Total

2001 2007 2001 2007 2001 2007

Northern 4.7 5.6 7.4 10.0 5.6 7.1

North-Eastern 2.6 4.1 3.7 5.5 2.8 4.3

Eastern 3.5 4.5 4.6 6.2 3.7 4.8

Central 3.6 4.3 3.4 5.0 3.6 4.4

Western 4.1 4.8 4.8 18.9 4.4 10.5

Southern 9.6 14.4 7.2 21.6 8.8 16.8

All - India 4.9 6.5 5.5 13.1 5.1 8.3

Source: RBI

Fig 21 -Sources of loans by income group (as a % of indebted earners)Annual income range < Rs 50k Rs 50 - 100k Rs 100 - 200k Rs 200 - 400k > Rs 400k Total

Loan agencies

Institutional Sources 27.5 46.0 59.4 60.2 70.5 32.8

- Banks 13.0 34.5 49.3 51.6 62.8 19.1

- Co-operative Societies 4.9 6.7 8.6 3.6 4.1 5.3

- Micro - Finance Institutions 1.1 1.0 0.7 0.5 2.4 1.1

- Self - Help groups 8.5 3.9 0.8 4.5 1.2 7.3

Non-institutional Sources 72.5 54.0 40.6 39.8 29.5 67.2

- Relatives / Friends 35.1 32.1 26.5 22.2 22.1 33.9

- Moneylenders 34.9 19.6 12.0 11.8 5.5 30.8

- Others 2.5 2.3 2.1 5.8 1.9 2.5

Total 100.0 100.0 100.0 100.0 100.0 100.0

Source: IIMS, 2007; RBIs Report on Currency and Finance 2006-08

35% of low-income earners rely on

local moneylenders


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11

Poor institutional penetration drives up interest ratesAs mentioned, lower access to credit from banks and other institutional sources has ledto higher reliance on moneylenders for the low-income group. Moneylenders are willingto finance the emergency needs of these sections without much documentation and areflexible on the loan amount, duration and repayment schedule; but, their flexibilitycomes at a price. As per the IIMS survey 2007, more than 40% of Indias population in

the lowest two income quartiles generally avail of loans at an annual rate of 36%or more.

Fig 22 -Lending rates by income group (% of indebted earners)% of population in income quartile who have taken loans from

sources in the last two yearsIncome quartile36% pa

Lowest Income quartile 16.0 16.9 18.7 48.4

Second Income quartile 22.8 18.8 18.7 39.7

Third income quartile 29.1 26.1 18.7 26.2

Highest income quartile 40.4 24.5 11.7 23.4

Total 22.6 19.4 17.7 40.4

Source: IIMS, 2007; Prof. Raghuram Rajan committee report on financial reforms

Why government efforts at financial inclusion have stumbledIn its 2009 report titled A Hundred Small Steps, the committee on financial sectorreforms, chaired by Prof. Raghuram Rajan, discussed the reasons behind the mixedresults of government initiatives towards financial inclusion. Some of the key reasonsoutlined in this report are:

Broad nature of priority sector norms: As mentioned, the RBI has mandated thatdomestic and foreign banks lend at least 40% and 32% of their respective bankcredit to certain priority sectors. However, the broad definition of eligible prioritysectors (for example 18% required in the agriculture segment) gives banks the

leeway to focus on bankable customers within the sector (viz. rich farmers). Banksalso aggressively push housing loans to meet the desired norms as home loansbelow Rs 2mn have priority-sector status.

Unprofitable nature of lending: As per theRBI mandate, banks must provide smallloans (up to a credit limit of Rs 200,000) at an interest rate not higher than theBPLR. This interest rate ceiling deters banks as smaller loans generally involvehigher operating cost and have higher perceived risk. Thus, low-income applicantsare generally denied loans one of the reasons why a higher number of rural andsemi-urban branch inaugurations by banks (especially PSU banks) has failed toincrease the availability of credit to the weaker sections.

Cumbersome documentation: Stringent documentation and collateral requirementsfor bank loans also hamper the passage of bank credit to weaker segments. A largeproportion of the low-income group is illiterate and has no financial history, leavingthem unable to fulfil the documentation requirements. Further, since theirborrowings are typically induced by medical and financial emergencies, NBFCs andinformal sources like moneylenders are preferred for quick processing of loans.

Failure of co-operative banks: Regional rural banks and co-operative banks, set upby the government to widen the credit net, have failed to make a mark. Most ofthese institutions are mired in serious financial troubles due to poor corporategovernance and lax loan assessment and monitoring policies.

Moneylenders are flexible on loan

terms; but their flexibility comes at a

price

Broad definition of priority sectors gives

banks scope to selectively grant credit

Interest rate ceiling on such loans deters

banks


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12

Financial overview

AUM expected to log 67% CAGR over FY09-FY12MAGFIL has reported strong business growth during FY06-FY09 with total assets undermanagement in gold loans increasing at a 125% CAGR (including MAFIT). This growthhas been driven by an aggressive expansion of branch network (9-fold increase to 645branches over the period) and easier availability of funding from banks.

In order to sustain its growth momentum, MAGFIL intends to open 250 branches eachyear, scaling up to 1,400 by FY12 and over 1,600 by FY13. It has already rolled out 120branches in H1FY10, taking its overall tally to 765. As operations at newer branchesmature, we expect a considerable increase in gold loans outstanding per branch fromRs 19mn in FY09 to Rs 42mn in FY12. This will aid a 69% CAGR in gold AUM overFY09-FY12 to Rs 58.6bn. Total AUM is expected to be marginally higher at Rs 58.9bn(67% CAGR), as the contribution of other products such as business loans andcommercial vehicle (CV) loans climbs down to less than 1%.

Fig 23 -Branch network to double over FY09-FY12

0

200

400

600

800

1,000

1,200

1,400

1,600

FY06 FY07 FY08 FY09 FY10E FY11E FY12E

(No.)

Source: RHH, Company

Fig 24 -Average loans outstanding per branch to increase

0

5

10

15

20

25

30

35

40

45


(Rs mn/Branch)


Fig 25 -AUM set for 67% CAGR over FY09-FY12

0

10,000

20,000

30,000

40,000

50,000

60,000


(Rs mn)


Fig 26 -as disbursement ramps up

0

50,000

100,000

150,000

200,000

250,000


(Rs mn)


NIMs to remain in 1315% rangeWe believe that penetration of banks and co-operatives in lower income householdswill remain low in the short to medium term, leaving credit requirements of this segmentto be met by NBFCs like MAGFIL, micro-finance institutions and local moneylenders. Asa result, we expect contracted yields for the company to remain strong at 2324%. Withlower loan tenure, the average yield realized will be higher at 2527%. We expect thecost of funds to decline by ~100bps in FY11 as MAGFIL will raise more commercial

paper to fund incremental disbursement. Thus, the net interest margin (NIM) shouldremain in the 1315% range, supporting net interest income (NII) growth of 72% overFY09-FY12 to Rs 8.3bn.

Expect a 67% CAGR in AUM over

FY09-FY12 as newer branches ramp up

Firm yields and a reduction in cost of

funds would ensure best-in-class NIMs


13/19


13

Fig 27 -NIMs to remain among the best in industry

23.7 23.4 24.0 23.8

12.7 12.411.5 10.8

15.4

14.8

13.013.0

0

5

10

15

20

25

30

FY09 FY10E FY11E FY12E

12.0

12.5

13.0

13.5

14.0

14.5

15.0

15.5

16.0Yield on assets Cost of funds NIMs (R) (%)(%)


Fig 28 -NII to grow by 72% CAGR over FY09-12E

0

2,000

4,000

6,000

8,000

10,000

FY08 FY09 FY10E FY11E FY12E

(Rs mn)


Higher operating leverage will augment profitabilityMAGFILs operating expenses are primarily fixed in nature. Consequently, with higherbranch productivity (loans outstanding per branch), we expect the cost/income ratio todecline from 48% in FY09 to 36% in FY12 and operating expenses/assets ratio todecline from 6.5% to 5.7%. We are also factoring in credit losses of ~0.3% of totaloutstanding gold loans. Provisioning expenses are estimated to decline from FY09 levelsdue to a run-down of the CV portfolio where delinquencies are higher. With operatingefficiencies and lower provisioning expenses, we expect PAT to log a 93% CAGR overFY09-FY12 to Rs 3.4bn. ROE is likely to improve from 31% in FY09 to 3335% in thesame period despite assumed 20% equity dilution in FY11.

Fig 29 -Operating leverage to improve

47.3 47.6

44.6

38.236.3

7.8

6.5

5.75.8

6.0

25

30

35

40

45

50


5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Cost to income ratio

Opex to asset ratio (R)

(%)(%)


Fig 30 -PAT CAGR pegged at 93% over FY09-FY12

0

500

1,000

1,500

2,000

2,500

3,0003,500


(Rs mn)


PAT to log a 93% CAGR over FY09-FY12 to Rs 3.4bn


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14

Valuation

Highly profitable business model with strong growth potential

We believe that gold-based financing can provide immense opportunities for NBFCs inIndia due to the lower penetration of credit among less-privileged households and the

large amount of accumulated gold stock in India. In addition, we expect bankingpenetration in the weaker sections to remain low in the near to medium term, whichwill keep lending rates high (at ~24%) and support the current ROE of 30%-plus forNBFCs operating in this segment. MAGFIL, with its expertise in lending against gold tothe weaker sections, provides an opportunity to invest in a highly scalable and profitablebusiness model.

Initiate coverage with Buy rating and target of Rs 682The MAGFIL stock has appreciated sharply in the last six months due to rising investorinterest and is currently trading at 2.4x FY11E ABV (assuming 20% equity dilution inFY11 at Rs 550/share). We believe the stock should trade at a premium to other NBFCsdue to the lower risk involved in the gold-based financing business and the companyssuperior ROE trajectory of 35%-plus in the next three to four years. We have valued the

stock at 2.8x FY11E ABV based on the residual income model (cost of equity of 15%and stable ROE of 24%), which gives us a target price of Rs 682. We initiate coverageon MAGFIL with a Buy rating.

Fig 31 -Price to 1-yr forward book value

0

200

400

600

800

Apr-08

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

(Rs)

1.0x

2.0x

3.0x

4.0x


Fig 32 -Comparative valuationsPrice Mcap P/BV (x) NIMs (%) RoE (%) EPS growth (%) Gross NPA (%)

(Rs) (Rs mn) FY10E FY11E FY09 FY10E FY09 FY10E FY11E FY09-11E CAGR FY09

MAGFIL# 573 17,475 4.7 2.4 13.0 13.0 30.9 33.8 34.6 65.6 1.9Shriram Transport Finance 466 98,756 3.2 2.5 7.8 7.6 29.6 28.8 28.8 25.9 2.3

M & M Finance* 315 30,548 1.8 1.6 ~12.0 NA 20.5 16.8 17.5 21.3 8.7

Shriram City Union* 401 18,391 2.0 1.7 ~11.0 NA 15.4 21.5 20.5 34.1 2.1

Source: Company, RHH, * Bloomberg # Consolidated financials and market cap, Assuming 20% equity dilution in FY11;

Lower-risk business and high ROEs

warrant premium valuations


15/19


15

Key concerns

Sharp decline in gold prices

Gold loans constitute more than 96% of MAGFILs total advances. The average LTV onits loan portfolio is only 75%; however, ~45% of outstanding loans have an LTV of

80100% and may be considered as risky assets. As more than 75% of the loans arerepaid within six months, credit losses will increase only if gold prices decline sharplywithin a 612 month period. Higher replacement cost and emotional attachment tojewellery pledged with the company provide further comfort on asset quality.

Regulatory riskProviding loans to the weaker sections of society is a politically sensitive issue. Whilewe believe that the regulator or government will not try to control the interest ratecharged on gold loans due to the continued thrust on improving financial inclusion (byencouraging banks and NBFCs to enter into this segment), any attempt to regulate thelending rates can significantly impact the companys profitability. Currently, NBFCs areexcluded from the Moneylenders Act; however, any change in regulation to bringNBFCs under the purview of this act will adversely impact growth and profitability.

Competition risk

We believe that competitive pressure in the gold loan financing segment will increasesignificantly in the next few years, primarily from other NBFC and micro-financeinstitutions, due to higher ROE potential and lower perceived risk with gold ascollateral. We do not expect banks to play a major role in this segment due to theceiling imposed on small loan interest rates. While we believe that MAGFIL will remaina key player in this segment given the scale, technology and expertise acquired overseveral decades, higher competition can lead to a decline in NIMs enjoyed by thecompany.

Fraud and reputation riskMAGFIL stores all the pledged jewellery in a strong room located in every branch. Any

theft of jewellery can significantly impact the companys reputation. MAGFIL insures thewhole value of these assets (gold loans plus making charges) with Oriental InsuranceCompany and therefore monetary losses will be insignificant in the case of theft.However, given the emotional attachment of the jewellery pledged, any theft willadversely impact client confidence.

~45% of outstanding loans are

vulnerable to a drop in gold price

NBFC and micro-finance institutions are

more of a threat than banks


16/19


16

Company profile

Incorporated in 1992, Manappuram General Finance & Leasing (MAGFIL) is a Kerala-based deposit-taking NBFC. The company is primarily engaged in providing loansagainst used jewellery (generally made of gold). Its customer base consists of the lowerincome segments which are currently not serviced by banks and other co-operatives,and are therefore mainly dependent on NBFCs, micro-finance institutions, relatives ormoneylenders for their credit needs.

Highly profitable business model

Since its client base has limited access to the banking system and short-term emergencyfinancing needs, MAGFILs lending rates are generally high (24%-plus). This has allowedthe company to report best-in-class NIMs of 1315% on its loan portfolio and an ROE of30% plus. The average tenure of loans is only three months and credit losses are verylow at 0.20.3% of total AUM, due to an average LTV of ~75% and the use of gold ascollateral. The company was also active in the vehicle loan segment; however, due tohigher delinquencies in this space, it is currently running down this portfolio.

Merger with sister company underwayMAGFIL is in the process of merging its sister company, Manappuram Finance (TamilNadu) or MAFIT, with itself. MAFIT is a non-deposit-taking NBFC with a major presencein Tamil Nadu, active in the gold financing business since 2003. Approvals for themerger have been obtained from the stock exchanges and market regulator; courtapproval is expected shortly. Current promoter shareholding in MAGFIL is 33.7% whichwill increase to 44.8% post the merger with MAFIT.

Fig 33 -Shareholding Patten

Public

33%

PE Investors

33%

Promoters

34%

MAGFIL

Public

4%

PE Investors

33%

Promoters

63%

MAFIT

Public

22%

PE Investors

33%

Promoters

45%

MAGFIL (merged)

Source: Company

Expanding in a big wayThe Manappuram group (MAGFIL and MAFIT) has witnessed strong growth since 2005

due to easy availability of funds from banks and other financial institutions through termloans and securitisation. The group has rapidly expanded its presence from only 71branches as on 31 March 2006 to 765 branches as on 30 September 2009. Total AUMhas increased more than 12-fold to Rs 17.8bn during the same period. Afterconsolidating its position in Kerala, the group is now expanding in other southern states(Andhra Pradesh, Karnataka and Tamil Nadu) as well as western and northern India. Itplans to open 250 branches in each of the next three years and increase its AUM to Rs100bn by FY13.


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17

Consolidated financials*

Profit and Loss statement Key ratios

Y/E March (Rs mn) FY09 FY10E FY11E FY12EInterest earned 2,999 5,212 8,738 12,927

Interest expended 1,348 2,321 3,359 4,582

Net interest income 1,651 2,891 5,379 8,345

Non-interest income 83 91 101 113

Net revenue 1,734 2,983 5,480 8,457

Operating expenses 825 1,329 2,096 3,072

Pre-provisioning profits 909 1,654 3,384 5,386

Provisions & contingencies 181 57 99 149

PBT 729 1,596 3,285 5,236

Income tax, Interest tax 251 549 1,130 1,801

Net profit 478 1,047 2,155 3,435

Balance sheetY/E March (Rs mn) FY09 FY10E FY11E FY12E

Cash and bank balances 2,677 1,742 2,231 2,452

Loans and advances 12,596 25,539 40,492 58,937

Other current assets 857 1,043 1,764 2,619

Investments 11 11 11 11

Net block (inc CWIP) 336 526 676 794

Total assets 16,477 28,862 45,173 64,813

Share Capital - Equity 228 305 365 365

Preference share capital 40 40 40 -

Options/warrants/others 30 - - -

Reserves & surplus 2,260 3,380 8,394 11,224

Net worth 2,518 3,685 8,759 11,589

Secured loans 4,711 10,399 16,314 24,799

Unsecured loans 896 4,641 8,071 14,409

Assignments 7,765 8,930 10,046 11,051

Current liabilities & provision 561 1,180 1,957 2,979

Deferred Tax liability (14) (14) (14) (14)

Total liabilities 16,477 28,862 45,173 64,813

Per share data

Y/E March FY09 FY10E FY11E FY12E

Shares outstanding (mn) 28.9 30.5 36.5 36.5

FDEPS (Rs) 27.7 34.3 59.0 94.1

DPS (Rs) 1.5 4.1 8.9 14.1

Book value (Rs) 87.0 120.8 240.0 317.5

Adjusted book value (Rs) 83.5 115.4 235.4 312.5

Y/E March (Rs mn) FY09 FY10E FY11E FY12EValuation ratios (x)

P/E 20.7 16.7 9.7 6.1

P/BV 6.6 4.7 2.4 1.8

P/ABV 6.9 5.0 2.4 1.8

Return ratios (%)

Interest spread 10.9 11.0 12.5 13.0

Net interest margin 13.0 13.0 14.8 15.4

Yield on assets 23.7 23.4 24.0 23.8

Cost of funds 12.7 12.4 11.5 10.8

Non-int Inc/ Total income 4.8 3.1 1.8 1.3

Opex cost/ Total income 47.6 44.6 38.2 36.3

ROE calculation (%)

Net interest income/Assets 13.0 13.0 14.8 15.4

Non interest income/Assets 0.7 0.4 0.3 0.2

Net revenue/Assets 13.7 13.4 15.0 15.6

Operating expense/Assets 6.5 6.0 5.8 5.7

Provision/Assets 1.4 0.3 0.3 0.3

Taxes/Assets 2.0 2.5 3.1 3.3

ROA 3.8 4.7 5.9 6.3

Equity/Assets 12.2 13.9 17.1 18.8

ROAE 30.9 33.8 34.6 33.8

Growth ratios (%)

Net interest income 95.1 75.2 86.0 55.1

Total income 97.1 72.0 83.7 54.3

Pre-provisioning profit 96.1 81.9 104.6 59.1

Profit 71.2 119.1 105.8 59.4

EPS 9.1 24.0 71.9 59.4

Book value 169.6 38.8 98.6 32.3

Adjusted book value 210.0 38.1 104.1 32.7

Asset quality (%)

Gross NPA 1.9 0.9 0.6 0.4

Net NPA 1.1 0.5 0.3 0.2

Business growth (Rs mn)

Disbursements 47,372 100,440 160,425 234,360

Growth (%) 72.6 112.0 59.7 46.1

AUM 11,977 25,110 40,106 58,590

Growth (%) 72.6 109.6 59.7 46.1

* MAFIT financials consolidated with MAGFIL


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18

Quarterly trend

Particulars Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10

NII (Rs mn) 411 442 526 613 709

YoY growth (%) NA NA NA 89.8 72.5

QoQ growth (%) 27.1 7.5 19.1 16.5 15.6

Total income (Rs mn) 413 451 528 627 718


QoQ growth (%) 25.4 9.2 17.3 18.7 14.5

PPP (Rs mn) 160 210 217 267 404


QoQ growth (%) 14.0 31.2 3.3 22.9 51.3

Adj net profit (Rs mn) 105 141 140 175 266


QoQ growth (%) 12.9 34.6 (0.4) 25.1 51.7

Company profile

Established in 1992, Manappuram General Finance & Leasing

(MAGFIL) is the flagship of the Kerala-based Manappuram Group.

MAGFIL provides loans against gold and primarily targets the non-

bank-worthy borrower segment which offers higher margins. To

gain scale and strengthen its distribution network, the company has

approved a scheme of amalgamation with its sister company

Manappuram Finance Tamil Nadu (MAFIT) and is currently

awaiting regulatory approval. The merged entity will have anextensive distribution network of over 750 branches and a

450,000-strong customer base.

Shareholding pattern *

(%) Mar-09 Jun-09 Sep-09

Promoters 60.0 61.0 61.0

FIIs 3.7 3.7 3.7

Banks & FIs 3.7 3.6 5.4

Public 32.6 31.7 29.9

*Shareholding pattern of MAGFIL (Standalone)

Recommendation history

Date Event Reco price Tgt price Reco

14-Dec-09 Initiating Coverage 573 682 Buy

Stock performance

350

400

450

500550

600

650

Sep-09 Oct-09 Nov-09 Dec-09

Buy


19/19

Documents

Manappuram General Finance & Leasing - Initiating Coverage 14Dec09