Manappuram PDF

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February 15, 2010

Gold Financing

THEMATIC

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Potholes on the road to El DoradoWhilst the recent RBI clarification removing gold loans from the prioritysector will decrease funding for the sector, we are positive on the longterm prospects of gold loan NBFCs because of: (i) the unavailability offormal debt finance for a large part of the Indian population and theabundant availability of gold as collateral; (ii) the quick and hasslefree loan delivery provided by NBFCs vs banks; and (iii) the increasingreach and acceptability of this form of finance. Manappuram is thebest play on this theme given its branch strength, strong brand name,

well developed gold appraisal skills and strong risk management. Weinitiate with a BUY.

Despite short term funding concerns, our positive stance on the sector and themain NBFC in this segment Manappuram is driven by:

Demand of credit and availability of collateral: Indias credit:GDP ratio isone of the lowest globally at ~4% due to the unavailability of formal bankingservices for a large part of the population. Banks and NBFCs have tried to tapinto this potential in the past by offering unsecured personal loans but thoseinitiatives did not succeed due to heavy defaults on these portfolios (even inbenign economic conditions). Loans against gold jewelry have thereforeemerged as a major alternative to tap this latent credit demand as Indians haveabout 18K tones of gold (~10% of total world gold stock) mostly in the form ofjewelry worth ~$800 bn.

Increasing market share of NBFCs: Whilst the total estimated gold loanmarket is ~$50-60 bn, the entire organized lending sector put together hasonly ~25% market share in this business and specialized NBFCs have ~8%market share in this business. We expect the market share of NBFCs to growfurther at the expense of banks and moneylenders as: (i) NBFCs have quickand hassle free loan delivery vs banks because of their specialized goldappraisal skills; (b) NBFCs charge lower interest rates and have a better imagethan moneylenders; and (c) NBFCs are acquiring a new set of borrowers viathe rapid expansion of branches and heavy advertising fronted by well knownmovie stars.

Initiate with a BUY on Manappuram (MGFL.IN, $1.0 bn mkt cap, 36%upside): Whilst the recent RBI clarification removing gold loans from the

priority sector is likely to impact the growth and NIMs of Manappuram, thecompany has adequate sources of funding to grow its loan book at a healthypace of ~38% CGAR between FY11-13 and maintain its ROAs (as animprovement in operational efficiency would largely mitigate the adverseimpact of NIM compression). Over the last 2 months the stock price hascorrected by ~45% from its peak and at 1.9x FY12 P/BV we believe that all thenegatives are priced in. We initiate with a BUY.

External factors are the major risks:A sharp decline in gold prices by 40%or more (similar to what happened in the early 1980s) and further regulatoryand political intervention are the major risks for the sector and forMannapuram.

Analyst contacts

Pankaj Agarwal, CFATel: +91 22 3043 [email protected]

Krishnan ASV

Tel .: + +91 22 3043 [email protected]

Poonam Saney

Tel: +91 22 3043 [email protected]

Recommendation

CMP: Rs106

Target Price (Period): Rs143

Upside (%) 36

EPS (FY11E): Rs7.6

Change from previous (%) NA

Variance from consensus (%) 6

Stock Information

Mkt cap: Rs44bn/US$963mn

52-wk H/L: Rs190/62

3M ADV: Rs215mn/US$4.7mn

Beta: 0.7x

BSE Sensex: 18,105

Nifty: 5,426

Stock Performance (%)

1M 3M 12M YTD

Absolute -21.2 -41.3 50.9 -29.6

Rel. to Sensex -17.2 -31.1 38.8 -18.3

Performance (%)

10,000

15,000

20,000

25,000

15-Feb-10 8-Jul-10 26-Nov-10

50

100

150

200

Sensex M anappuram Gen. Fin.

Source: Bloomberg, Ambit Capital research


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Indian Gold Financing- The Road to El Dorado with some potholes

Ambit Capital Pvt Ltd 2

Gold financing has come of ageGold financing has been a popular form of financing in India for many decadesdue to the unavailability of formal financing options for a large chunk of the Indianpopulation. Industry sources peg the size of the total gold loan market to Rs. 2.5-3.0 trn (implying ~10% of the value of the total gold in the hands of the Indians).However, historically this has been a fragmented market largely catered to by

small moneylenders and pawn-shops (~75% market share).

Over the last five years, the gold financing market has caught the fancy oforganised lenders, especially NBFCs, who are not only increasing their marketshare at the expense of unorganized sector, but are also expanding the market byexpanding into new geographies, introducing innovative products and spendingheavily on marketing. The gold loan portfolio of organised players has increasedat a CAGR of ~48% between FY07-10. Within this segment, specialized NBFCs(e.g. Manappuram, Muthoot) have grown their loan books at a much faster pace(~70%) during FY07-10.

Exhibit 1: Growing size of the organized gold loan

market ( Rs bn)

25

120

250

375

515

0

100

200

300

400

500

600

FY02 FY07 FY09 FY10 FY11

CAGR 40%

Source: Manappuram using ICRA data, Ambit Capital

Exhibit 2: Increasing market share of NBFCs in the

organized sectorFY07 FY09 FY10

Public Sector banks 52% 51% 47%

Pvt Sector banks 15% 14% 12%

NBFCs 18% 24% 32%

Co-operatives 15% 12% 10%

Total 100% 100% 100%

Source: Manappuram using ICRA data, Ambit Capital

and has the legs to grow further

Despite growing their portfolio at a CAGR of ~48% over FY07-10, we believe thatorganised players are well placed to continue growing at a similar pace over thenext 3-4 years. Our optimism is based on three factors:

An increase in the total potential market size due to increased goldholdings: As per the World Gold Council, Indians hold about 18k tones ofgold (~10% of total world gold stock) worth $800 bn. Just as importantly,Indians add ~700 tonnes to their gold portfolio every year and ~75% of thesegold holdings are in the form of jewelry. Historical data suggests that thedemand for gold in India has been relatively inelastic to gold prices and inspiteof gold prices growing at a CAGR of 13% over the last decade, the demand forgold has been robust. Hence looking at historical trends and Indias healthyGDP growth rate and savings rate, we believe that the total gold stockavailable (in volume terms) can continue to rise at a CAGR of ~5% for the nextdecade. Moreover, although we do not have a view on the evolution of theprice of gold, it is reasonable to assume that gold prices can continueincreasing at a 5% CAGR based on the last 90 year history of gold prices(2000-10 CAGR of gold prices is 13%). Hence we estimate that the total valueof gold holdings in India can increase at a 10% CAGR over the next 5 years.

Increased penetration from organized players: Organized players wouldnot only benefit from this increased market potential as explained above butalso from the increased penetration of the industry driven by:


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1. Increased reach: Organized sector players (especially NBFCs) are rapidlyexpanding their reach by opening new branches in their existing and newgeographies (e.g. Manappuram expanded its branch network ~7x over thelast four years). Moreover, banks like HDFC are increasingly offering theseproducts through an increasing number of branches.

2. Increased acceptability of the product: Furthermore, thanks to heavyadvertising through the print and electronic media using movie stars and

sports personalities, the organized sector is not only eating into marketshare of unorganized players but also trying to shed the stigma attached topledging jewelry. This we believe can bring a new set of borrowers to theindustry.

3. Better rates and services: Whilstwe believe that the demand for thegold financing product is not interest rate sensitive, banks and NBFCs areoffering gold loans at much lower rates than the unorganized players(12%-24% vs ~36%-60% by local moneylenders and pawnshops).Moreover the organized players score over local moneylenders in terms ofquick disbursals and higher confidence in the lenders ability to keep theborrowers gold safely.

4. Unsecured financing drying up: Between FY09-11 banks and NBFCssuffered substantial losses on their unsecured loan portfolios (e.g. ICICIBank, Reliance Capital, India Infoline, Cholamandalam Finance etc.). Sincethen the organised sector has become wary of unsecured financing. Thisshould help the gold financing segment. Anecdotal evidence to supportthis point can be found from global trends as well where banks reluctanceto advance unsecured loans post the Lehman crisis led to the growth inpawnbroking in both the US and the UK.

Exhibit 3: Potential Size of the Indian gold loan market

FY02 FY07 FY09 FY10 FY11E FY12E FY13E FY14E FY15EFY10-15E

CAGR

Gold holdings (in Tonnes) na na 17,000 17,700 18,300 19,000 19,700 20,400 21,100 4%

Gold Holdings in (Rs. Bn) 6,462 11,669 25,000 32,000 36,600 40,260 44,286 48,715 53,586 10%

Organised loan industry as a %of total value of gold holdings

0.4% 1.0% 1.0% 1.2% 1.4% 1.60% 1.8% 2.0% 2.2%

Organised gold loan industry(Rs. Bn)

25 120 250 375 515 644 797 974 1,179 26%

Share of NBFCs (%) NA 18% 24% 32% 50% 55% 60% 65% 70%

Total Gold AUM of NBFCs(Rs. Bn)

NA 24 57 121 264 354 478 633 825 47%

Source: Historical estimates from Manappuram using ICRA estimates, Ambit Capital research

NBFCs are better placed than banks

Whilst banks provide lower interest rates than NBFCs (~13%-15% vs 18%-24% byNBFCs), given the small ticket size (~Rs. 30K) and low duration of the product(~100 days), this difference in interest cost is not particularly apparent to theborrower. Hence we believe that within the organized segment, specialized NBFCslike Manappuram and Muthoot are better placed than banks and their loanportfolio will grow faster than banks in this segment because of:

Better reach to customers: NBFCs are quickly growing their branch networkin the key catchment areas. Banks find this difficult to replicate as: (i) banksget limited branch licenses from the RBI which they would prefer to usekeeping in mind their overall growth strategy rather than just the needs of thegold finance segment; and (ii) it takes time for banks to fully operationalise abranch given the infrastructure needed to open a bank branch.


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Better products and service: Due tothe very nature of this loan product (ashort term liquidity product for borrowers with ~100 days average duration),quick and hassle free delivery of gold loans is a key competitive advantage.Moreover, since the borrower normally pledges his family jewelry, he wants topledge the minimum amount of jewelry to get the desired amount. NBFCshave advantage on these parameters as they have experienced gold valuers inall their branches (in-fact all the new hires at these NBFCs go through

extensive gold appraisal training before they join a branch). This helps them toquickly and accurately value the pledged jewelry and hence helps them quicklydisburse the loan (in 10 minutes as per the personal experience of the authorof this note) and provide higher LTV (up to 85%) to the customers.

Sources of Competitive Advantage

Whilst on the face of it gold financing business looks like any other financingbusiness with no visible competitive advantages, deeper scrutiny points to thefollowing key competitive advantages in this sector:

Reach/distribution channel: Given that gold loans are generally liquid loans where the borrower is in urgent need of funds and given the borrowers

unwillingness to travel beyond a certain distance from his home (due to therisk and cost associated with travelling long distances), local branch baseddistribution is a key competitive advantage. However, given the need forexperienced staff who can appraise the gold jewelry and provide robustoperational risk management, it is not easy for a new entrant to roll outbranches rapidly. NBFCs have an advantage over banks on this front as due totheir low operational cost in running a branch, they are able to add branchesfaster than banks.

Trust and brand name: Once the lender is near the customer, the lenderthen needs the customers trust in his ability to safely store the pledged gold.Banks have a natural advantage over NBFCs on this parameter given theirlong operating history and a general reputation for safety. Moreover, bankslonger track record in providing locker facilities also helps. However, NBFCsseem to have acknowledged this and are spending heavily on brand buildingby hiring popular movie stars and sports personalities (advertising expenses forManappuram were 14% of its net revenues in FY10 vs 9% in FY08). NBFCs arealso spending on risk and safety measures by regularly auditing the gold stockat all branches, installing safety vaults and CCTV cameras.

Quality of products and services: Given that gold loans are meant toprovide short term financing, the ability to provide higher LTV loans and quickdisbursal of the same is a key competitive advantage. The key to providehigher LTV and quick disbursal lies in accurately and quickly appraising thequality of the gold. NBFCs like Manappuram and Muthoot score over banks on

this parameter as due to their decades of experience in this business, theyhave been able to develop multiple check and balances to accurately appraisethe quality of gold quickly. This has helped them in building a product portfoliowith interest rates ranging from 12%-24% depending on LTV and the type andquality of gold. Banks on the other hand are at a disadvantage here due totheir weaker domain knowledge and hence are not able to offer higher LTVloans. Instead banks for the most part sell a single standardized gold loanproduct with an LTV of less than 65%..

Managing Operational risk:As lendershandle a large amount of cash andgold on a daily basis in branches scattered across the country, they are at riskof employee theft, burglary and fraud (i.e. taking spurious gold as collateral).Decades of experience in these businesses have helped specialised NBFCs like

Manappuram and Muthoot develop systems and procedure to counter theserisks. However, for newer NBFCs in this segment (like India Infoline, Karvy,etc.) the lack of such experience and knowledge will be an obstacle to scale uptheir operations and compete with established players.


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Exhibit 4: Competitive assessment of the various players in the gold financing industry

Parameter

SpecialisedNBFCs like

Manappuramand Muthoot

Banks

New NBFCs whoare entering the

segment (e.g.Karvy, IIFL)

Local moneylenders

Comments

Reach anddistribution

channel

Due to aggressive branch expansion, established NBFCshave better reach than banks as banks dont offer thisproduct through all their branches. New NBFCs only

have presence in limited geographies and moneylendersare confined to their respective localities.

Brand nameand trust

Banks score well on this parameter because of their longoperational history. However, established NBFCs have astrong brand name in southern India and are trying tobuild pan-India brands through heavy advertising.

Products andservices

NBFCs because of their ability to quickly appraise thevalue of the gold and swiftly disburse the loan have anadvantage over banks.

Ability tomanageoperationalrisk

Banks because of their internal checks and proceduresare able to adequately manage operational risk.Established NBFCs because of their decades ofexperience have been able to develop the systems todeal with operational risk effectively. For new NBFCs,dealing with operational risks whilst scaling up their

operations would be a challenge.

Overall

Source: Ambit Capital research

Note : - Strong; - Relatively Strong; Average; - Relatively weak.


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How do gold prices affect this sector?

Given that: (i) ~30% of the growth in the loan portfolio of the major NBFCs overthe last four years has been driven by the increase in gold prices, and (ii) NBFCsprovide up to ~85% LTV on gold jewelry, a drop in gold prices can impact both thecredit quality and growth of the sector. Whilst gold has been steadily rising overthe last decade, there have been multiple instances in the past where gold priceshave declined sharply and languished for a long period of time

Exhibit 5: Periods of declining gold prices

Period No. of days

Fall in goldprices

during theperiod

Maximum 3monthdecline

Maximum6monthdecline

Maximum 1 yeardecline

Comments

From Aug73-Dec73

120 days 21% 21% na na After correcting by 21% in 4months, prices went back to theearlier levels within a month.

From May74Aug74

90 days 18% 18% na naAfter declining 18% in 3months theprices went back to earlier levels

within 3 months.

From Feb75-Aug76

560 days 43% 21% 25% 36%

Gold had a losing streak of 18months where it lost 43% and ittook another 18 months to reachat previous levels.

From Oct78-Nov78

16 days 19% na na naA sharp decline of 19% within 16days. It took around 80 days forthe gold to reach its previous levels

From Jan80-Mar80

57 days 43% 40% na na

A sharp decline of 43% in lessthan 2 months. Whilst the goldbounced back 20% in the next 9months, it took 28 years for thegold to reach the peak that ithit in Jan80.

From Sep80-Jun82 640 days 57% 27% 32% 41%Lost ~57% in 21 months. It tookgold 25 years to return to itspre- decline prices!

Feb83-Feb85 740 days 44% 16% 19% 28%44% decline over 2 year periodtook close to 35 months to reachthe peak prices

Feb90-Jun90 130 days 18% 14% na Na

Feb97-Jan98 315 days 23% 16% 17% Na

Source: Ambit Capital research, Bloomberg,

The last 90 years of data on historical gold prices show that there have been nine

instances when gold prices have fallen more than 15% within a 3 month periodand two instances when they have fallen more than 25% within a 3 month period.

Impact of a price correction on credit quality

Due to limited listing history of gold loan companies, we do not have data onimpact of a sharp gold price correction on gold financers credit quality. However,we believe that the impact would be lower than what one might instinctively expectit to be. Given that specialized NBFCs have an average LTV of around ~75% ontheir gold loan portfolio and have around 25% of their portfolio at ~85% LTV, astraight forward conclusion would be that a 25%+ correction in the gold price canbe catastrophic for the sector. However, a closer look suggests that things are not

as simple as that. LTV is calculated on the scrap value of the gold: NBFCsnormallyprovide

loans against household used jewelry and not against gold bars. Theycalculate the LTV on the scrap value of the gold. This improves the margin of


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safety for them in the event of a fall in gold prices as thevalue of the jewelry isnormally ~15-20% higher than the scrap value of the gold as it includes themaking charges of the jewelry and the valuable stones embedded in thejewelry. Hence the replacement cost of the jewelry for the borrower is muchhigher than the scrap value and this makes willful default less likely even if thegold price corrects.

Emotional quotient: Normally the borrowers pledge their family jewelry andhence have some emotional attachment to the jewelry. Hence the borrowershave an emotional incentive to repay even if they are slightly out of money.We believe that this adds an additional ~5% margin of safety for the lender.

Shorter duration of the loans: Theaverage duration of the jewelry loans isaround ~100 days and around ~65% of the loans are repaid within 90 daysand 85% within 180 days. Only 15% of the loans go beyond 180 days. Hencethe sector is insulated to a significant extent from a gradual decrease in goldprices.

Lenders have option to make margin call and enter into optionscontracts: Some lesser know features of gold financing contracts mitigate to agreat extent the NPA risk in the event of sharp decline in gold prices: a) thelender has right to make a margin call if the LTV falls below their comfortlevel; b) the lender has the right to sell the pledged gold even before thecompletion of loan tenure in case the LTV crosses 90%; and c) the lender hasright to enter in to gold options on behalf of the client to hedge the gold pricerisk.

That being said, lenders are unlikely to sell the pledged gold to mitigatedefault risk as they are likely to loose that customer forever and sufferreputational damage.

Hence we believe that whilst from the lenders perspective the average LTV is 75%,including making charges of the jewelry and some margin of safety due to theborrowers emotional attachment to the jewelry, prices have to fall by at least

35%-40% for borrowers to willfully default on their loans. Hence even in the worstcase scenario based on historical trends (when gold prices fell 40% within 2months in 1980), write-offs for the Manappuram would be ~4% of the loan book.This could be absorbed by the company within a single year since the companyhas an ROA of ~5%.

Impact of a price correction on loan book growth

The data suggests that ~30% of the loan growth of major NBFCs over the last 5years has been driven by the increase in the gold prices (which increased at aCAGR of ~19% between FY06-11). Whilst the monthly volatility in gold pricescould have a limited impact on growth, a structural decline in gold prices similar to

the 1980s could seriously impact the growth of the sector as the average tenure ofthe loan is only ~100 days. Hence a decline in gold prices can bring down theloan growth as the: (i) loans get repriced at lower rates and the potential marketsize decreases with the value of the gold, and (ii) a steep fall in gold prices canshut out marginal customers who do not have sufficient amount of gold to meettheir loan requirement.


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Removal of priority sector status impactsprofitability and growth

Until recently a major portion of loans originated by gold financing NBFCs wereclassified as priority sector advances. Hence Indian banks, who need to advance40% of their advances to priority sectors, met some portion of this requirement bybuying loan portfolios from gold NBFCs and advancing loans to them. This was not

only a cheaper (~150-200 bps lower cost of funds on these advances) but also aeasily available source of funding for gold NBFCs (~55% of Manappuramsfunding was through this route) as banks were happy to lend to gold loan NBFCsunder the priority sector category without breaching their sectoral cap on NBFCs.

However, on 3rd February, 2011 the RBI said that gold loans no longer beclassified as priority sector loans. This new guideline will impact the growth andprofitability of the sector as:

Increase in cost of funds: Since the cost of funds which came through thepriority sector were ~150-200 bps cheaper than normal bank borrowings,removal of priority sector status would increase the cost of funds for goldNBFCs. For Manappuram, we expect the cost of funds to go up by ~110 bps

as 55% of its funding came from banks through priority sector loans.

Availability of funds: Since loans to gold NBFCs were classified as prioritysector, the banks were happy to advance loans to these NBFCs withoutbreaching their sectoral advance caps to NBFCs. However, under the newregime, gold NBFCs would have to compete with other NBFCs as well as othersectors to secure funding from banks. We believe this could be a short termchallenge for Manappuram given the current tight liquidity environment.Constrained credit availability in turn could affect its growth for some time.However, we believe that in the medium-to-long term the company would tideover this obstacle as healthy profitability, stable credit quality (NPAs less than


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Exhibit 7: Impact analysis of RBI removing gold loans from priority sector (taking Manappuram 3QFY11 financials)

As a % of average assetsPre RBI

guidelinesPost RBI

guidelinesComments

Yield on advances 23.17% 23.17% The RBI guidelines does not impact lending rates

Cost of funds 9.15% 10.25%

~55% of borrowed funds of Manappuram were through prioritysector route where Manappuram was getting these funds at ~200bps cheaper than normal borrowings. These 55% funds will get

repriced at 200 bps higher rates resulting in ~110 bps increase incost of funds.

Spreads 14.02% 12.92%

Opex 6.77% 6.77%

Loan loss provisions 0.46% 0.46%Operational expenses and credit quality do not get impacted bythe new rule

Pre Tax ROA 6.79% 5.69%

Post Tax ROA 4.48% 3.75% Impact of 70 bps on ROA

Assuming optimal leverage 8.33 6.66 ROE is a function of leverage and prior to new guidelinesManappuram could have leveraged up to 8.33 times in theoptimal conditions as they were required to set aside 15% capitaladequacy only for the 80% of loans which were on the booksreducing effective capital requirement to only Rs. 12.5 for Rs.100 of AUM (i.e. 15% of Rs. 80 on book loans). In the new regimethe company will have to set aside capital adequacy of 15% forentire portfolio of Rs, 100 implying capital adequacy requirementof Rs. 15.

ROE 37.32% 25.00%

Source: Manappuram, Ambit Capital research* Please not that above analysis is only for illustration purpose and not our estimates for the company.

Regulatory/political risk is there more to come?

The Indian specialty finance sector has been at the wrong end of regulatory andpolitical intervention in the recent past:

Andhra Pradeshs state ordinance on microfinance institutions (MFIs) in Oct10has led to mass default by borrowers in that state.

In Jan11, a committee set up by the RBI on microfinance institutions (theMalegam Committee) proposed capping the interest rates charged by MFIsand imposing many other restrictions on their business operations.

As explained in the previous section, on 1st February, the RBI removed prioritysector status on gold loans originated by NBFCs.

In light of this, there are fears of further regulatory intervention. Two major riskswhich investors are anticipating are:

The RBI capping rates charged by gold financing companies; and State government intervention in the gold financing sector along the lines of

what the Andhra Pradesh state ordinance did to MFIs.

Will RBI cap the interest rates?: Whilst it is difficult to anticipate the RBIspolicy making regarding gold financing companies, we believe that the probabilityof the RBI capping interest rates charged by gold financing companies is low:

The RBI removing gold loans originated by NBFCs from priority sectoreffectively means that the RBI does not think that these loans are going to thepoorer/credit starved section of the society. Hence the need to cap interestrates presumably does not arise.

Different customer Profile small businessmen and the middle class:Unlike the microfinance sector, which deals with customers who are very poorand do not have access to formal bank credit, gold financing companies caterto more middle class people and small businessmen (who use gold financing


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to meet their short term liquidity requirements). Hence the political or socialneed to intervene is more muted.

Further state government intervention?: Whilst gold financing NBFCs areregulated by the RBI, some state governments including Kerala (the state accountsfor the biggest proportion of the loan portfolios of Manappuram and Muthoot) want to regulate these NBFCs under the State Money Lenders Act. The KeralaState Money Lenders Act, amongst other things, caps interest rates charged bymoneylenders at 2% above the rates charged by banks. The act, however does notexplain which bank rate to be taken for this calculation as banks charge anywherebetween 8%-20% on different loan products. Hence it is difficult to calculate thefinancial impact of applicability of Kerala Moneylenders act applying on gold loanNBFCs.

Whilst the final decision on this matter is still pending with apex court of India, itscomforting that one of the technical committees set up by the RBI on this issuerecommended that NBFCs should not come under State Money Lenders Act andthe recent Malegam Committee report on microfinance also endorsed this view.

Exhibit 8: Conclusion - Porter analysis of Indian gold financing industry

Source: Ambit Capital research, Industry

Whilst a sharp decline in gold prices and regulatory changes could impact thegrowth and profitability of the sector, given the under-penetration of credit in Indiaand given the abundant availability of gold as collateral, we cannot but feel thatthe gold financing sector is well placed to grow rapidly.

Bargaining power of suppliersHigh

Given that the industry is still at anascent stage and requirescontinuous debt and equity capital,the bargaining power of capitalsuppliers (both equity and debt) ishigh.

Competitive intensityMedium

The competitive pressure facing

specialised gold NBFCs is not high

given their unique offering of better

service than banks and lower

interest rates and better safety than

moneylenders. However,

competition within NBFCs will

intensify with the entry of more

NBFCs in to the sector.

Barriers to entryMEDIUM

Whilst barriers to entry is not veryhigh to start small scale operations,scaling up operations needssubstantial capital, operationalknowledge, time and advertisingexpense. However, as the existingplayers gain substantial scale andbuild a trustworthy brand name inmajor catchment areas, it would betough for a new player to break in.

Bargaining power of buyersMedium

Given that alternative sources ofborrowing is limited for such borrowersand there are very few alternate avenuesto get financing at such a short notice, thebargaining power of customers is low.

Threat of substitution

LOW

Microfinance loans and unsecuredpersonal loans from banks and NBFCs arethe two other major substitutes for theborrowers. However, post recentdevelopments in the microfinance sector inIndia we believe that the availability offinance from this route would be limited.Moreover, as banks and NBFCs burnt theirhands in unsecured personal loans, theyhave scale down their unsecured loanbooks and have altogether exited from thissegment (e.g. IIFL, Reliance Capital,Cholamandalam etc.

Improving

Unchanged

Deteriorating


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Manappuram General Finance

(MGFL IN, mcap US$1.0bn, BUY, TP Rs 143, 36% upside):

Manappuram is the second biggest gold loan NBFC in India after Muthoot Financeand it is the only listed pure play gold loan NBFC. The companys loan book andprofitability has grown at a CAGR of more than 100% over the last 4 years whichhas resulted in a ~30x increase in its share price over the same period.

Whilst the recent RBI clarification removing gold loans from priority sector wouldimpact the growth and NIMs of Manappuram, the company has adequate sourcesof funding to grow its loan book at a healthy pace of ~38% CGAR between FY11-13 and maintain its ROAs as improvement in operational efficiency would largelymitigate the impact of margin compression. The stock has corrected ~50% from itspeak over the last 2 months and at 1.9x FY12 P/BV we believe that all thenegatives are already priced in. We initiate with a BUY.

.


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BFSI-Specialty Finance February 15, 2010

ManappuramBloomberg: MGFL Equity INITIATING COVERAGE

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

BU

Exhibit 9: Key financials

Year to March FY09 FY10 FY11E FY12E FY13E

Net Revenues 1,274 3,413 8,410 12,561 16,884

Operating Income 674 2,018 4,836 7,296 9,963

Net Profits 302 1,197 2,865 4,608 6,300

Diluted EPS (Rs) 2.2 4.1 7.6 11.0 15.0

RoA (%) 3.3% 5.6% 5.0% 4.6% 4.6%

RoE (%) 23.2% 30.8% 22.4% 21.5% 24.1%

P/B (x) 10.9 5.9 2.3 1.9 1.5

Source: Company, Ambit Capital research

Analyst contacts

Pankaj Agarwal, CFA


Krishnan ASV

Tel .: + +91 22 3043 [email protected]

Poonam Saney


Recommendation

CMP: Rs106

Target Price : Rs143

Upside (%) 36

EPS (FY11E): Rs7.6

Change from previous (%) NA

Variance from consensus (%) 6

Stock Information

Mkt cap: Rs44bn/US$963mn

52-wk H/L: Rs190/62

3M ADV: Rs215mn/US$4.7mn

Beta: 0.7x

BSE Sensex: 18,105

Nifty: 5,426

Stock Performance (%)

1M 3M 12M YTD

Absolute -21.2 -41.3 50.9 -29.6

Rel. to Sensex -17.2 -31.1 38.8 -18.3

Performance (%)

10,000

15,000

20,000

25,000

15-Feb-10 8-Jul-10 26-Nov-10

50

100

150

200

Sensex M anappuram Gen. Fin.


The genuine articleWhilst the recent RBI clarification (which removed gold loans from thepriority sector) could impact loan book growth and NIMs,Manappuram has adequate sources of funding to grow its loan bookat a CAGR of 38% between FY11-13 and maintain its ROAs asimprovement in operational efficiency would mitigate the impact ofNIM compression. Over the last 2 months, the stock has corrected~45% from its peak and at 1.9x FY12 P/BV, all the negatives appearto be priced in. We initiate with a BUY.

Even after a 45% correction over the past 3 months, Manappurams shareprice is up ~30x over the last four years driven by a CAGR of 135% in netprofits between FY06-11. However, following the recent correction (which

was in part driven by a regulatory change from the RBI), at 1.9x FY12 P/BV allthe negatives seem priced into Mannapurams share price as:

Funding concerns are overdone:Whilstthe RBIguidelines will impacttheavailability of funding to some extent, we do not see funding drying up forManappuram as at 3QFY11 ~45% of its debt funding is from the non-prioritysector route (bank credit lines, CPs, NCDs). Even within priority sectorborrowings, only 35% was from selling loan portfolios to banks (a source ofcredit which seems likely to dry up); the remaining 65% were credit lines frombanks at slightly lower rates due to the priority sector tag.

Increased operating efficiency to mitigate margin compression: Whilstwe expect NIMs to compress by ~260 bps between FY11 and FY12 driven by(a) system wide rates rising (b) priority sector liabilities being repriced

upwards by ~110bps; (c) slight decrease in lending rates, the increasedoperational efficiency (opex as of % average assets declining by ~120 bps byFY13) should mitigate the impact on ROAs.

Loan book grow should be healthy:Whilst loan book growth seems likelyto slow down from its historical rate (120% CAGR between FY07-11), we stillexpect it to be healthy at 38% CAGR over the next 2 years driven byincreased business from the branches were opened in the last one year (52%of the branches) and the further roll out of ~1000 branches over the next twoyears.

ValuationIn a country where personal lending from the banks has almost stopped andwhere gold is a commonly available form of collateral, gold financing lookswell placed to continue growing rapidly. Mannpuram is the lender with themost well developed competitive advantages in the gold financing market.Our excess return model (using a cost of equity of 15% and perpetuitygrowth of 5%) values the firm at Rs.143 implying 36% upside (implied FY12P/B of 2.5x and FY12 P/E of 13.1x)


13/27

Manappuram General Finance & Leasing


Company Financial Snapshot

Company timeline

Year Event

1992 Company established

1996 Company goes public via an IPO

1999 Commencement of gold financing business

2007 PE funding of Rs. 700 mn from Sequoia and others

2008 PE funding of Rs. 700 mn from Ashmore and others

2009 Acquired sister company MAFIT from promoters

2010 Raised Rs. 2.5 bn through a QIP

2010 Preferential issue of Rs. 1bn to promoters

2010 Raised Rs. 10 bn through another QIP

Company Background

Manappuram is Indias second largest gold loanprovider with a loan book of Rs.~70 bn. The companyprovides loans against household jewelry and has

grown its loan book at a CAGR of 120% over the last 4years driven by its expanding branch network, a strongbrand name and the ability to swiftly appraise gold,make a lending decision and then structure a loan forthe retail or SME borrower.

Profit and loss account

Rs. mn FY10 FY11E FY12E

Net Income 3,413 8,410 12,561

Net Interest Income 3,306 8,249 12,392

Interest Income 5,351 11,765 20,666

Interest Expense 2,045 3,516 8,274

Fee Income 107 161 169Expenditure 1,395 3,574 5,265

Employee Cost 536 1,544 2,805

Other expenses 859 2,030 2,460

Operating Profit 2,018 4,836 7,296

Profit Before Tax 1,818 4,300 6,914

Net Profit 1,197 2,865 4,608

Diluted EPS (Rs) 4.1 7.6 11.0

Balance SheetRs. Mn FY10 FY11E FY12E

Sources of Funds

Shareholders' Funds 6,106 19,488 23,450

Loan Funds 25,434 64,158 93,437

Total Sources of Funds 31,539 83,646 116,888

Application of Funds

Fixed Assets 569 1,301 1,541

Investments 1,407 403 403

Cash and Bank balances 2,682 3,948 5,545

Net Loan book 25,871 74,835 104,962

Net Current Assets 1,010 3,159 4,437Total Applications ofFunds 31,539 83,646 116,888

BVPS (Rs) 17.9 46.7 56.2

Loan, revenue and net profit growth ROE decomposition (as a % average assets)

188%173%

55%

91%

95% 168%

178%

88%

162%

298%

43%

98%

0%

40%

80%

120%

160%

200%

240%

280%

320%

FY08

FY09

FY10

FY

11E

Loan book Revenues Net Profits

FY10 FY11E FY12E

Net Income 15.8% 14.6% 12.5%

NII 15.3% 14.3% 12.4%

Fee Income 0.5% 0.3% 0.2%

Operating Expenses 6.5% 6.2% 5.3%

Employee Expenses 2.5% 2.7% 2.8%

Other opex 4.0% 3.5% 2.5%

Operating Income 9.4% 8.4% 7.3%

Depreciation 0.7% 0.7% 0.1%

Loan loss provisions 0.3% 0.3% 0.3%

Pre Tax ROA 8.44% 7.47% 6.90%

Tax 2.9% 2.5% 2.3%

ROAA 5.6% 5.0% 4.6% Average Leverage(x) 5.5 4.5 4.7

ROAE 30.8% 22.4% 21.5%


14/27



Exhibit 10: SWOT analysis

Strengths Weaknesses

Strong branch network of ~1,800 branches spreadacross India.

Strong brand name in the gold financing in southIndia

Ability to quickly disburse gold loans based on the

gold appraisal skills developed over decades.

Strong risk management architecture to shield thecompany from employee thefts, burglaries and theuse of spurious gold as collateral.

The brand is relatively unknown outside south India.However, the company is trying to build its brandthrough heavy advertising.

Lack of a broad based funding base and heavy

dependence on banks for funding.

Opportunities Threats

Opportunity to grow its operations inunderpenetrated north India.

Opportunity to diversify in the related businesseslike selling gold coins and bars and financingthese purchases.

There is a potential regulatory threat that theinterest rates charged by gold lenders likeMannapuram could be capped. However, theremoval by the RBI of gold loans from the prioritysector somewhat reduces this risk.

State governments intervening in the operations of

gold lenders like Mannapuram.

A sharp correction in gold prices could lead to NPAsrising and/or reduce the potential size of the goldloans market.


Exhibit 11: Competitive assessment of the various players in the gold financing industry

Parameter ManappuramMuthootFinance

MuthootFinCorp

ShriramCity Union

Finance

Karvy,Indiainfoline

Comments

Reach anddistributionchannel

Manappuram and Muthoot have a widerdistribution reach from ~2000 branchescompared to City Union Finance (~600branches) and new players like Karvy andIndiaInfoline (who have a negligible branchpresence).

Brand Nameand trust

Both Manappuram and Muthoot have been inthe industry for decades and are the betterknown brands in the segment. Manappuramscores over Muhtoot on brand recognition asthe Muthoot brand name is more generic innature (there are already three big goldfinancing firms by the name of Muthoot whichcould lead to cannibalization and confusion).

Ability tomanageoperationalrisk

Because of their decades of experience in theindustry, Manappuram and Muthoot havedeveloped systems to deal with operationalrisks effectively. For new NBFCs, dealing withoperational risk whilst scaling up theiroperations would be a key challenge.

Overall

Source: Company, Ambit Capital research, Industry, Bloomberg,

Note : - Strong; - Relatively Strong; Average; - Relatively weak.


15/27



Mannapuram has come of age

Manappuram is India second largest gold loan NBFC with ~Rs. 70 bn in loanassets. From being one of the thousands of small cap companies listed on theexchanges, Manappuram has emerged as one of the top wealth creators in thecountry over the last 4 years with its stock price increasing by ~30x over the last 4years despite the recent 50% correction.

Rapid branch expansion (from 291 branches in FY07 to 1,795 now), the increasein gold prices (21% CAGR between FY07-11), the drying up of personal loans frombanks since the Lehman crisis and continuous funding from both debt and equityproviders has helped Manappuram to grow its loan book and revenues at a~120% CAGR over FY07-11.

Exhibit 12: Robust loan growth

55%

91%

188%

173%

-

10

20

3040

50

60

70

FY07 FY08 FY09 FY10 9MFY11

0%

50%

100%

150%

200%

Outstanding loan book (Rs. bn) YoY Growth (%)


Exhibit 13: with a proportional increase in revenues

174%

88% 95%

168%178%

-

1,000

2,000

3,000

4,000

5,000

6,000


0%

50%

100%

150%

200%

Net Revenues (Rs. mn) YoY Growth (%)


Exhibit 14: Healthy net profit growth

168%

298%

43%98%

162%

-

1,000

2,000

3,000

4,000

5,000

6,000


0%

50%

100%

150%

200%

250%

300%

350%

Net Profits (Rs. mn) YoY Growth (%) Source: Company, Ambit Capital research

Exhibit 15: ...but EPS growth has been lower due todilution

173%

62%

86%

27%

84%

0.0

1.0

2.0

3.0

4.0

5.0


0%

50%

100%

150%

200%

EPS YoY Growth (%) Source: Company, Ambit Capital research

and now has a bright future

We expect Manappuram to show continued growth in its top and bottom line(although at a slightly lower pace than it has done over the past five years) due tothe increased productivity of its recently opened branches (52% of the branchescurrently under operation were opened in the last one year), further branchexpansion and improved efficiency in the branches. These positive forces should

largely mitigate the negative impact of NIM compression (arising from theincreased cost of funds and the decrease in lending yields due to increasedcompetition). In this section we expand on these conflicting forces.


16/27



Loan book to grow at a CAGR of 38%

Mannapurams loan book has grown at a CAGR of ~120% between FY07-11 andmanagement is guiding the market towards loan growth at ~80% CAGR betweenFY11-13. However, we are skeptical about managements ability to meet thisguidance because of our concerns regarding the abundant availability of the fundsfollowing the recent policy change by the RBI which removed gold loans from thepriority sector (~55% of the borrowings of Manappuram were priority sector),uncertainty regarding the evolution of gold prices (which has driven ~40% of theloan growth between FY07-11) and lower business from the new branches due tolower availability and willingness to pledge gold in the rest of the India vis a vissouth India.

However, we believe that even with constant gold prices and with a slightimprovement in branch productivity, the company can achieve loan growth of 38%CAGR between FY11-13 (implying average loan book CAGR of ~58% betweenFY11-13 as the growth was back-ended in FY11):

(i) Funding to become more expensive but not dry up: Whilst funding islikely to become expensivepostthe recent RBI guidelinesremoving gold loansfrom priority sector, we cannot see funding drying up for Manappuram

completely. ~55% of the funding for Manappuram was coming throughpriority sector and only ~20% of the funding was through assignment of theportfolios (see table below). Our discussions with bankers suggest that whilstfunding through the securtisation route (which accounts for ~20% ofMannapurams funding) might dry up, the direct bank funding under prioritysector (which accounts for 35% of Mannapurams funding) would still continuebut at slightly higher rates (100-200 bps). Moreover, the company has twomore sources of funding which it has not fully explored as yet:

The Company has the highest credit rating available for Commercial Paper(CP)/NCDs. It can raise ~Rs.20 bn in CPs but has so far utilised only 5% ofthis limit.

Only ~5% of the funding for Manappuram comes from retail Non-Convertible Debentures (NCDs). Manappurams competitor MuthootFinance gets ~50% of its funding through this route suggesting thatMannapuram, a larger and more established firm, should also be able toavail of NCD funding.

Exhibit 16: Funding mix for Manappuram at the end of 3QFY11

Funding SourceAmount(Rs. Mn)

% contribution Comments

Bank Funding (a+b) 47,694 88%

a. Through PrioritySector

29,807 55%

Assignments 14,242 26%This is the part most impacted by the RBIpolicy change as it is no longer attractivefor banks to buy these portfolios

Working capital loansfrom banks

15,565 29%Interest cost likely to increase on theseliabilities by ~150-200 bps

b. Non Priority Bankfunding

17,887 33%This is unlikely to be affected as these arenormal working capital loans.

Non bank Funding 6,501 12%

NCDs 2,934 5%Can access this route. Rival MuthootGroup gets 50% of its funding throughthis route.

Subordinated bonds 1,628 3%

Subordinated debt 1,000 2%

CPs 913 2%

Company has the highest rating for

raising CPs. Can raise upto Rs. 20 bnOthers 25 0%

Total 54,195 100%

Source:Company, Ambit Capital research


17/27



(ii) Branch expansion and improved branch productivity: ~52% of thebranches in Manappuram have been opened over the last one year. In thesebranches the average portfolio is still below Rs. 10 mn whereas in the olderbranches, the average loan portfolio is in the range of Rs. 40-150 mn. Goingforward we expect the business from the new branches to increase as theybecome mature as they benefit from heavy advertising and marketing byManappuram. Over and above that, the addition of ~1000 more branches

over the next 2 years should further add to loan book growth.

Exhibit 18: Loan growth analysis for Manappuram

FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Total Gold loans (Rs. Mn)* 3,176 4,914 9,381 25,589 74,740 104,962 141,510

Loan Growth (YoY) 55% 91% 173% 192% 40% 35%

LTV 48% 45% 48% 69% 70% 70% 70%

Value of the gold stock (Rs. Mn) 6,592 10,942 19,372 37,267 106,771 149,946 202,158

Average Gold prices per gram (Rs.) 930 1,189 1,452 1,660 2,017 2017 2017

Gold Stock (MT) 7.09 9.2 13.3 22.5 52.9 74.3 100.2

Gold pledged per customer (grams) 48.8 41.2 39.8 40.9 46.2 48.5 51.0

No. of customers 145,371 223,039 335,156 549,172 1,145,279 1,531,811 1,966,845

Customer per branch 500 512 520 546 573 613 656

Number of branches 291 436 645 1,005 2,000 2,500 3,000

Portfolio per branch (Rs. Mn) 18.2 19.5 25.9 35.4 37.4 42.0 47.2

Average Ticket Size per customer ('000) 21.9 22.0 28.0 46.6 65.3 68.5 71.9Source: Company, Ambit Capital. *Including securtised/assigned loans

Profitability is likely to fall

Between FY07-11, net profit for Manappuram grew at a 128% CAGR which ishigher than the loan book CAGR of 120% during the same period as: (i) cost offunds decreased for Manappuram (from ~11.8% in FY08 to ~9.2% in 3QFY11)due to improved credit ratings, and (ii) operational efficiency improved betweenthis period as opex as a % of average assets fell from 7.0% in FY08 to 6.8% in3QFY11.

However, going forward we expect net profits to grow at slightly lower rate (~48%CAGR between FY11-13) than the growth in average loan book (~58% CAGR

between FY11-13) as it seems likely that there will be some compression in netinterest margins due to: (i) the cost of funds increasing by ~100-150 bps due tothe RBI removing gold loans from priority sector; (ii) the decline in the lendingyields as competition increases in the gold loan sector in the wake of new playersentering the market. However, enhanced operational efficiency will offset to asignificant extent the adverse impact of fallings NIMs. We describe these dynamicsin more detail in this section.

NIMs to decline but still stay healthy: Between FY08-11, Manappuram hasmaintained net interest margins in the range of 15%-18%. Going forward weexpect net interest margins to decline to ~13.5% by FY13 as:

(i) Cost of funds for Manappuram are likely to increase by 100-150 bps as the

double whammy of system wide interest rates rising kicks in and the removalby the RBI of gold loans from priority sector bites (leading to ~55% ofMannapurams liabilities being repriced at ~200 bps higher); and

Exhibit 17: Increasingbranch productivity

YearPortfolio per branch

(Rs. Mn)

FY07 13.4

FY08 18.2

FY09 19.5FY10 25.9

3QFY11 35.8



18/27



(ii) Increased competition from other NBFCs (like Shriram City Union, Karvy, IndiaInfoline, etc.) which have recently entered the gold loans market leads to a100-150 bps decline in lending yields.

Exhibit xx: NIMs to decline but still at healthy level

23.0%23.0%25.0%

29.0%24.9%

27.5%

11.8%10.7% 8.9% 10.5%

10.5%

14.5%

13.6%13.8%16.4%

17.9%16.8%15.6%

0%

10%

20%

30%

FY08

FY09

FY10

FY11E

FY12E

FY13E

Yield on advances (%) Cost of funds (%) NIMs (%)Source: Company, Ambit Capital

Improved operational efficiency to compensate for NIM erosion: WhilstManappurams operational efficiency have improved marginally between FY08-11with operating expenses as a % of average assets decreasing from 7% in FY08 to6.8% in Q3FY1, going forward we expect operational expenses to decrease furtherto 5.6% of average assets by FY13 as:

~64% of the firms branches have been opened in the last two years and areyet to reach their optimal capacity. Whilst some of the expenses related tobranches (eg. rent and electricity) will increase with inflation and employeeexpenses are likely to rise up with competition heating up in the sector, theincrease in such expenses will be outpaced by the loan book growth that thesebranches will show as they move towards optimal capacity (see Exhibit 17 on

page 17). Advertising expenses for Manappuram have been ~33% of total expenses

(~1.2% of average AUM) in FY10 and FY11. These expenses have increased ata CAGR of 162% between FY06-11 as company has heavily spent on brandbuilding by hiring well known movie stars. Clearly, these expenses are totallydiscretionary in nature. Even if assume Manappuram maintains its advertisingexpenses, they are likely to come down as a % of average assets.

Exhibit 19: Operating efficiency to improve further with scale

7.0%

8.4%8.0%

6.8%6.2%

5.9% 5.6%

3%

4%

5%

6%

7%8%

9%

10%

FY08 FY09 FY10 Q3FY11 Q4FY11E FY12E FY13E

Opex as a % of avg assets (%)


Credit quality to remain stable with a sharp decline in gold prices beingthe main concern: Creditquality trends have been stablefor the company in thepast with NPAs in the gold loan business being less than ~1% over the last twoyears. Manappurams superior credit quality is driven by the following factors:


19/27



The average loan to value (LTV) of the Manappuram loan portfolio is ~70%.Hence the chances of willful default are relatively low as the borrower isincentivised to pay up and reclaim his jewelry.

Mannapuram calculates LTV without including the value of the precious stonesembedded in the jewelry. Including the value of stones and taking account ofmaking charges makes it even less likely that borrowers will willfully default ona loan.

Gold prices have been continuously rising over the last decade. Hence even inthe cases of default, Manappuram has been able to recover its loans andinterest by selling the pledged jewelry.

Manappuram offers loan against jewelry which households have used forsome time and to which the borrower usually has an emotional attachment.This further reduces the chances of willful default.

Therefore, we expect credit quality trends for Manappuram to remain stable unlessthere is a sharp correction in the gold prices. The key question then becomesWhat if gold prices correct sharply?. Our sensitivity analysis based on theLTV breakup of Manappuram portfolio shows that if we assume a worst case

scenario of a 40% fall in the gold prices within three months (this sort of correctionhas not happened in the last 30 years), the total write-offs after recoveries couldbe ~4.0% of the portfolio which could be absorbed by a years earning ascompanys ROA is ~5% (see table below explaining the maths).

Exhibit 20: LTV breakup of the portfolio

% of loans

26%

17%

6%10%

4%2%

34%

1%

95%


Exhibit 21: Sensitivity of Mannapurams NPAs to a goldprice fall

3 month fall in gold pricesPortfolio write offs* in the case of

willful defaults

40% fall 4.0%

30% fall 1.0%

20% fall NA10% fall NA

Source: Company, Ambit Capital. To factor in making charges and theemotional quotient, we have reduced ~15% from disclosed LTV to arriveat effective LTV and have assumed that ~35% of the borrowers who aredue after 3 months will default below their effective LTV. The write-offnumbers are calculated after factoring in sell of pledged gold at scrapvalue.

Comfortable capital adequacy: Manappuramis a registered NBFC with the RBIand hence needs to meet the RBI guidelines of 15% capital adequacy ratio (CAR)

by Mar12. Manappuram did a QIP in Nov10 (~$250m) which boosted its CAR to~32.4%. However, the recent RBI notification that gold loans should not beclassified as priority sector loans means that ~20% of Manappurams loan book(which the company had assigned to banks in bilateral transactions) would nowstay on its books. This would reduce Manappurams CAR to ~25.5%. Even then,based on our loan growth projections (FY11-13 CAGR of 38%), this lenders CARwould be above the mandatory 15% until FY13.


20/27



Exhibit 22: Capital adequacy to remain above regulatory levels

40.8%

31.7%29.3%

22.6% 19.3%17.7%

16%

20%

24%

28%

32%

36%

40%

44%

FY08 FY09 FY10 FY11E FY12E FY13E

Capital Adequacy RatioSource: Company, Ambit Capital research

However, if the loan book growth is higher than our expectations (and is nearer tothe management guidance of ~80% between FY11-13), Mannapuranm wouldhave to raise more equity by late FY12 or early FY13. Clearly, this dilution wouldnot necessarily be bad for the shareholders because if management is able to

meet its guidance, the P/B multiple would be much higher than what we areassigning to the company in the valuation section of this note.


21/27



Key assumptions & estimates

Exhibit 23: Key assumptions and estimates for Mannapuram (all figures in Rsmn unless otherwise mentioned)

FY09 FY10 FY11E FY12E FY13E Comments

Assumptions

Number of branches 645 1,005 2,000 2,500 3,000 Branch expansion numbers based on historical trendsand management guidance

Customers per branch520 546 573 613 656

Customers per branch will increase with increasedbranch productivity as the newly opened branchesmature

Gold pledged percustomers (gms)

39.8 40.9 46.2 48.5 51.0Increase in the amount of gold pledged per customerbased on historical trends and increased per capitagold holdings

Gold prices per gram(Rs) 1,452 1,660 2,017 2017 2017

We do not have a view on gold prices and hence haveassumed constant gold prices in the near future

LTV ratio 48% 69% 70% 70% 70% Assuming constant LTV on the gold pledged

Yield on advances

27.5% 29.0% 25.0% 23.0% 23.0%

Decrease in yield due to increased competition in the

segment

Cost of funds 11.78% 10.66% 8.94% 10.5% 10.5%Increase in cost of funds due to rising systematic ratesand gold loans being removed from priority sector

No. of employees perbranch 6.3 6.9 8.2 8.2 8.2

Expense per employee(Rs000) 81.3 97.6 132.6 152.5 175.4 In line with general salary rise in India

Rent per branch(Rs000) 101 162 217 239 263 In line with inflation

Advertising expenses(Rsmn) 82 482 1,081 1,024 1,024

Other expenses (Rsmn) 181 243 623 899 1,232

Key Outputs (YoY growth)

Loan Book 9,381 25,589 74,740 104,962 141,510 FY11-13 CAGR of 38% vs FY09-11 CAGR of 182%.

Net Revenues 1,274 3,413 8,410 12,561 16,884 FY11-13 CAGR of 42% vs FY09-11 CAGR of 157%.

Operating Income 674 2,018 4,836 7,296 9,963 FY11-13 CAGR of 44% vs FY09-11 CAGR of 168%.

Profit After tax 302 1,197 2,865 4,608 6,300 FY11-13 CAGR of 48% vs FY09-11 CAGR of 208%.

EPS 2.2 4.1 7.7 11.1 15.1 FY11-13 CAGR of 40% vs FY09-11 CAGR of 87%.


Ambit versus consensus

Exhibit 24: Ambit v/s consensus

(Rs mn) Consensus Ambit % change

Net Revenues

FY11E 7,940 8,410 6%

FY12E 13,152 12,561 -4%

Net profits (Rs)

FY11E 2,668 2,865 7%

FY12E 4,547 4,608 1%



22/27



Our FY11 numbers are ~6% above consensus estimates as we are expecting theimpact of new RBI guidelines to crystallize in FY12 and not in Q4FY11.

Absolute valuation

We have valued Manappuram using an excess return to equity model which isbased on Net Profits (cost of equity x beginning of the year book value) for allthe future years discounted back to the present using a cost of equity of 15%.

We have explicitly forecast net profits for FY11, FY12 and FY13 based on theassumptions in the table above.

Between FY13-FY20, in order to mimic the impact of rising competition, wehave faded the loan book growth from 35% to 10% and ROA from 4.6% to4.0%.

From FY20 we have assumed terminal growth of 5%

Based on these assumptions our excess return model values Manappuram atRs143 per share (implied FY12 P/B of 2.5x and FY12 P/E of 13.1x) , implying36% upside from current levels.

Relative valuation

Exhibit 25: Relative Valuation

NBFCs Price Mcap RoA (%) RoE (%) P/BV (x) P/E (x)

(Rs) (USD bn) 2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E

Power Finance Corporation 264 6.7 2.9 2.8 18.7 18.6 2.0 1.6 11.3 9.8

Dewan Housing Finance 264 0.6 1.9 1.9 19.6 19.5 1.9 1.6 11.4 8.7

LIC Housing Finance 178 1.9 2.0 1.8 23.5 22.8 2.1 1.7 9.9 8.5

IDFC 139 4.5 3.3 3.3 14.5 13.8 1.9 1.7 14.9 11.7

Shriram Transport Finance 698 3.5 4.3 4.3 28.3 28.2 3.3 2.6 12.8 10.4

M&M Finance 696 1.7 4.2 4.2 23.5 24.1 3.1 2.5 14.6 11.3

SREI Infrastructure Finance Ltd 46 0.2 2.2 2.4 15.2 19.0 0.6 0.5 6.4 4.6

REC 247 5.4 3.3 3.2 21.0 21.4 1.9 1.6 9.7 8.2

SKS Finance 643 1.0 3.5 3.4 14.3 12.7 2.4 2.1 19.9 14.2

Average of above 3.0 3.0 19.7 19.9 2.1 1.8 12.2 9.7

Manappuram Gen. Fin. &Leasing 91 1.0 5.4 5.1 22.8 23.9 2.3 1.9 16.4 9.5

Premium or Discount toabove

77% 70% 16% 20% 8% 9% 34% -2%


Mannapuram currently trades at 1.9x FY12 book value and 9.5x FY12 earnings which is at 8% and 33% discount respectively to its closet peer SKS which webelieve is unjustified given that gold financing is a much better business modelthan unsecured microfinance model.

Key risks to our stance

All three key risks to our positive stance on Manappuram are external in nature:

A sharp decline in gold prices: a decline of more than 40% in gold priceswithin a quarter with gold prices then staying at those depressed levels formore than a year could seriously impact credit quality for Manappuram as the

likelihood of willful defaults would increase in such a scenario. We takecomfort from the fact that such a sharp correction in gold prices has not beenwitnessed for 30 years. Our sensitivity analysis shows that such scenario coulderode Manappurams entire year profitability.


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Gold losing its status as a precious commodity: Gold does not have asmuch utilitarian real value like other commodities (e.g crude, steel, etc.) andits value is primarily driven by the perceived notion that it is a valuablecommodity. Hence any changes at the global level which could erodeconfidence in the commodity would be damaging for gold prices and hence forMannapuram.

Regulatory and political intervention: Whilst we do not foresee the RBI

capping interest rates for gold loans following its decision to remove goldloans from priority sector, we cannot rule out such an irrational decision beingtaken under political pressure. Moreover, whilst the Supreme Court of Indiahas still to give its verdict on validity of Kerala Moneylenders Act on NBFCslike Manappuram, If the verdict goes in favour of Kerala government state, itcould affect Mannapurams operational flexibility and lending yield in the stateof Kerala (~19% of Manappurams loan book comes from this state).


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Exhibit 26: Balance sheet

Year to March (Rs mn) FYO9 FY10 FY11E FY12E FY13E

Sources of Funds

Shareholders' Funds 1,679 6,106 19,488 23,450 28,869

Loan Funds 4,506 18,357 64,158 93,437 128,234

Secured loans 3,712 16,501

Unsecured loans 793 1,856

Total Sources of Funds 6,185 24,462 83,646 116,888 157,103

Application of Funds

Fixed Assets 280 569 1,301 1,541 1,733

Investments 11 1,407 403 403 403

Cash and Bank balances 1,134 2,682 3,948 5,545 7,475

Net Loan book 4,412 18,794 74,835 104,962 141,510

Net Current Assets 348 1,010 3,159 4,437 5,982

Total Applications of Funds 6,185 24,462 83,646 116,888 157,103

Total assets including assignments 11,566 31,539 83,646 116,888 157,103Source: Company, Ambit Capital research

Exhibit 27: Income statement

Year to March (Rs mn) FYO9 FY10 FY11E FY12E FY13E

Net Income 1,274 3,413 8,410 12,561 16,884

Net Interest Income 1,198 3,306 8,249 12,392 16,707

Interest Income 2,114 5,351 11,765 20,666 28,344

Interest Expense 916 2,045 3,516 8,274 11,638

Non-Interest Income 76 107 161 169 177

Fee based services 20 25 21 22 23

Other income 56 82 140 147 154

Expenditure 601 1,395 3,574 5,265 6,921

Employee Cost 284 536 1,544 2,805 3,942

Other operating expenses 317 859 2,030 2,460 2,979

Advertisements 82 482 1,081 1,024 1,024

Rent 54 133 326 538 723

Others 181 243 623 899 1232

Operating Profit 674 2,018 4,836 7,296 9,963

Bad debts and provisiosn 178 142 379 122 200

Depreciation 34 57 158 260 308Profit Before Tax 462 1,818 4,300 6,914 9,454

Taxes 160 621 1,434 2,307 3,154

Tax rate 35% 34% 33% 33% 33%

Net Profit 302 1,197 2,865 4,608 6,300

Basic EPS 2.2 4.1 7.7 11.1 15.1

Diluted EPS 2.2 4.1 7.6 11.0 15.0



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Exhibit 28: Ratio analysis

Year to March (%) FYO9 FY10 FY11E FY12E FY13E

Loan Growth (YoY) 92% 173% 192% 40% 35%

Yield on advances- Calculated 27.5% 29.0% 25.0% 23.0% 23.0%

Cost of funds- Calculated 11.78% 10.66% 8.94% 10.5% 10.5%

Spreads 15.7% 18.3% 16.1% 12.5% 12.5%NIM-Calculated 16.81% 17.91% 16.44% 13.79% 13.56%

Cost to income ratio 47.1% 40.9% 42.5% 41.9% 41.0%

Opex as a % avg assets 8.4% 8.0% 7.1% 5.9% 5.6%

Gross NPAs (gold loans) 1.66% 0.94% 0.55% 0.31% 0.31%

Net NPAs (gold loans) 0.18% 0.13% 0.18% 0.14% 0.14%

CAR 40.8% 31.7% 29.3% 22.6% 19.3%


Exhibit 29: Valuations

Year to March (%) FYO9 FY10 FY11E FY12E FY13E

P/E 61.1 48.2 26.0 13.9 9.6P/BV 17.0 10.9 5.9 2.3 1.9

ROA 3.9% 3.3% 5.6% 5.0% 4.6%

ROE 34.7% 23.2% 30.8% 22.4% 21.5%

Dividend Yield 0.2% 0.3% 0.5% 1.0% 1.5%



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Institutional Equities Team

Saurabh Mukherjea,CFA

Managing Director - Institutional Equities (022)30433174

[email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Amit K. Ahire Telecom / Media & Entertainment (022) 30433202 [email protected]

Ankur Rudra, CFA IT/Education Services (022) 30433211 [email protected]

Ashish Shroff Technical Analysis (022) 30433209/3221 [email protected]

Ashvin Shetty Consumer (022) 30433285 [email protected]

Bhargav Buddhadev Power/Capital Goods (022) 30433252 [email protected]

Chandrani De, CFA Metals & Mining (022) 30433210 [email protected]

Chhavi Agarwal Infrastructure (022) 30433203 [email protected]

Gaurav Mehta Derivatives Research (022) 30433255 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin Infrastructure (022) 30433241 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Parikshit Kandpal Construction / Real estate (022) 30433201 [email protected]

Poonam Saney BFSI (022) 30433216 [email protected]

Puneet Bambha Power/Capital Goods (022) 30433259 [email protected]

Rajesh Kumar Ravi Cement (022) 30433274 [email protected]

Ritika Mankar Economy (022) 30433175 [email protected]

Ritu Modi Metals & Mining (022) 30433292 [email protected]

Subhashini Gurumurthy IT/Education Services (022) 30433264 [email protected]

Vijay Chugh Consumer (incl FMCG, Retail,Automobiles) (022) 30433054 [email protected]

Sales

Name Designation Desk-Phone E-mail

Deepak Sawhney VP - Ins Equity (022) 30433295 [email protected]

Dharmen Shah VP - Ins Equity (022) 30433289 [email protected]

Dipti Mehta Senior Manager Equities (022) 30433053 [email protected]

Pramod Gubbi, CFA VP - Ins Equity (022) 30433228 [email protected]

Sarojini Ramachandran Director, Sales +44 (0) 20 7614 8374 [email protected]


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Explanation of Investment Rating

Investment Rating Expected return(over 12-month period from date of initial rating)

Buy >15%

Hold 5% to 15%

Sell

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