Gold loan rate per gram for today is Rs. 4,247. This article is based on a sustained analysis of the impact of gold price on the profitability and business prospects of gold loan companies. As per our research, it is clear that the decline in gold price would result in the growth of volume as the number of funds required by the customer does not change. This means that the gold loan companies will not see any significant drop in their asset growth. Also, the margins of the companies can expand as customers would prefer higher LTV loans. Therefore, there would only be a slight drop in the profits even though provisioning is higher. On this basis, we firmly believe that the business of loan against gold is hugely profitable, and it would generate more than 3% or even in the long term.
We are expecting robust growth of earnings for both Mannapuram and Muthoot. We expect 60% growth for Manappuram and 52% growth in earnings for Muthoot. The RoA for both companies is expected to be in the range of 4-4.5%. The stock performance in the past few months hasn’t been good, which suggests that the street is concerned about the correction of gold price. Since the Q3 earnings are likely to beat the expectation, we recommend BUY on both Manappuram and Muthoot.
When people look at the high growth of gold loan companies, they tend to conclude that it is due to the high rally of gold price. However, we think that the loan is dependent on the requirement of the borrower, which does not change based on the price of gold. No doubt that higher gold price encourages borrowers to meet their requirements through the gold loan, but if you look from the perspective of gold loan companies then their book profile also becomes safer by reducing average LTV. When this happens, the AUM growth is more durable than the growth of volume.
When there is a sustained gradual correction in the gold price, then we think that the volume takes a jump as the requirements of the borrower does not change. Also, the maximum customers of gold loans are in rural or semi-urban areas where the alternative source of funds is either not accessible, or it’s more costly. This means that the asset growth would not take a major hit, but it will be below the volume growth if gold price starts correcting. As the gold price would decrease, the customer would migrate to higher LTV loans which also have a higher rate of interest as they successfully plan and design their personal budget.
Currently, both Mannapuram and Muthoot are witnessing exceptional growth. For Manappuram the YOY growth is at 114% while QOQ growth is 17%, and for Muthoot YOY growth is at 81% whereas, QOQ growth is 17%. However, even though there has been a substantial network expansion, the quarterly addition in pledged gold has reduced in the last five quarters. This clearly shows the inverse relationship between the prices of gold and volume growth. The fund requirement of customers is inelastic. We think the gold companies will have healthy AUM growth even if the gold prices correct itself. If we assume an 18% decline throughout Q4, we still estimate 35% AUM growth for Manappuram and 28% AUM growth for Muthoot.
Another objective of our analysis is to study the impact of gold prices on the profitability of the business. We have recognized that gold price has a holistic effect on the volume growth, risk profile, margin, operating leverage and provisioning. As per our working RoA will be unchanged or improve slightly in case of a drop in gold prices. As we mentioned before, the correction of gold prices would result in a higher LTV average and improvement in the margin. The operating leverage is expected to drop slightly, and there would be an increase in the provisioning. As per our observation, the profit in the lower price scenario will only be slightly less, although RoA can be better due to the smaller base. Current RoA of Manappuram is 4.5-5%, and for Muthoot, it is 4-4.5%. We do not expect them to drop even if the gold price starts going south.
In the past three quarters, there has been a substantial increase in funding cost; still, both Muthoot and Mannappuram have been able to maintain their margin. The most surprising thing was these companies managed success in the face of increasing competition which is offering lower interest rates. Both of them shifted their funding mix to NCDs and CPs from banks. In the August-September, both Mannapuram and Muthoot succeeded in completing issues of NCD worth Rs. 4.4 bn and Rs. 6 bn respectively.
The quarterly performance of both gold companies has been high. We can at least expect to see a 15% QOQ growth in AUM and earnings.