Muthoot Capital Services

Dear Donald,

Thanks for the detailed work. MCS is certainly a bet where probability of making money at current valuations is very high. Although your note is very detailed, there are few things that needs to happen for a re-rating in the stock:

1). The current cost structure is designed to disburse INR 60 crs per month, whereas the current run-rate is pretty low. They need to achieve the target sooner, otherwise Cost to Income ratio will continue to look out of whack.

2). NPA - Roughly 15% of the book is 3W and that market is facing severe pressure. If they can handle this segment without much of NPAā€™s, that would be wondetful.

3). Main customers opening their own financing arm - Hero and Honda are the 2 biggest customers for MCS. Hero has already announced extending the reach of its financing arm for its 2-wheelers.

4). Rating - Since the current rating is in conjunction with its parent, till they donā€™t get a substantially better rating on their own, current cost of funds will continue to remain a challenge.

5). CAR - Current CAR of 19% with 50% loan growth and no profit growth will come under pressure very soon. Either the profitability needs to move up, or they need to raise Tier 2 capital to sustain the high growth momentum.

I am positive from a long term perspective on the company and on the stock.

Thanks,

Manav

Muthoot seems to be expanding into Rajasthan and Punjab (http://jobsearch.naukri.com/mynaukri/mn_newsmartsearch.php?searchtype=bpwjobs_page&phrase=MGOPERATIONSNAUK&tem=muthootgrp). They would need to build their brand, and fight with the big guys.

Disclosure: I have a small investment in MCS, but canā€™t get the conviction to buy more.

These ads are for Muthoot finance. It is a listed company from a different Muthoot group. MCS belongs to Muthoot Pappachan group and has no relation with Muthoot finance.

( Link: http://jobsearch.naukri.com/mynaukri/mn_newsmartsearch.php?searchtype=bpwjobs_page&phrase=MGOPERATIONSNAUK&tem=muthootgrp http://jobsearch.naukri.com/mynaukri/mn_newsmartsearch.php?searchtype=bpwjobs_page&phrase=MGOPERATIONSNAUK&tem=muthootgrp Link: http://jobsearch.naukri.com/mynaukri/mn_newsmartsearch.php?searchtype=bpwjobs_page&phrase=MGOPERATIONSNAUK&tem=muthootgrp ).

This is a PUBLIC Apology.

I failed to disclose I have significant vested personal interest in Muthoot Capital. I have been berated by several senior investors I respect - that this was necessary - given ValuePickr following today.

It was an oversight. I didnā€™t realise that - what is intended as a concise fact sheet on the company- Stock Story at ValuePickr - to start serious questioning in this thread - may have been seen by some as indirect promotion. The choice of my NO-BRAINER wording was unfortunate - some would say too-clever-by-half - an unintentional mistake.

DO NOT be influenced by the detailed noteā€¦thatā€™s just VP-style work to bring everyone on the same page quick-timeā€¦ leaving us free to concentrate on (missed) gaps. There are still a few serious questions unanswered (as many folks like Vinod MS, Manav Vijay and others have raised- and thatā€™s exactly the purpose of a VP Stock Story - to focus attention on the GAPSā€¦which get captured back againā€¦after due diligence is completed.

I will maintain silence - till we bring out the Management Q&A - that aims to provide the ammunition behind the stock story for all and help answer critical GAPS in understanding. I am still working on capturing back our intense interviewsā€¦ All I can say Management has been completely transparent in answering all that we could think of throwing at them, and some more.

Please note ValuePickr due diligence is deemed complete only after Stock Story and Management Q&A is thrown open for the full community to digest, absorb and critically examine.

Looking forward to that.

Disc: I have significant personal vested interest in Muthoot Capital. My views are biased. Please do your own homework and consult investing experts before making any investment decisions.

How about a CODE OF CONDUCT - during Stock Story/Management Q&A and possible Recco - for ValuePickr Core Team and any others hand-picked for critical time-sensitive assignments/scuttlebutts/Stock Story/Management Q&As and the like

a) Publish the CODE of CONDUCT to be followed at VP (take in public comments)

b) Enforce the CODE strictly

c) Admin maintains list of VP Core Team and assigned Folks company-specific basis (will remain private but can be produced on a company specific (and time-specific basis for repeat follow-up interactions)

These are some of the suggestions that have been floated by well-meaning senior ValuePickrs and well-wishers from the larger investment community. Welcome specific suggestions from all members - please post in new Code of Conduct thread - not here.

The way this stock has moved up, it seems the larger valuepickr community has taken the stock story as the stock recommendation. Please be informed that the stock story is just the first step towards understanding the stock. It may have many gaps and those gaps need to be discussed, investigated. Please do not chase the stock blindly. Do your own due diligence before investing. This forum is meant for the stock discussion.

Coming to my disclosure on muthoot capital, I Hold a small position of around 2% of portfolio in muthoot. I would be inclined to buy more once I see margins improving.

My disclosure - have been part of the stock story and management visit. Iā€™m invested.

Ayush

Disclosure: I was part of the team which did management meet and I have invested.

Vinod

Hi,

Very nicely covered stock story. Some very basic questions from my side.

a) avg lending rate is more or less around 28%. Around borrowing rate has increased over last 3 years. When interest rate cycle reverses (hopefully soon), we could see NIM expansion ?

b) What has caused the lending rate to reduce by 170 points in 9mfy14. Is it because of increased competition ? How can they sustain these margins ? If you go to two wheeler showroom, if there are a couple of loan providers (NBFC/banks), customer can go for the one who provide the lowest interest rate (like any commodity business).

c) why is dividend payout ratio at 25% ? When they struggling for getting capital from banks for disbursements , why they are paying such high dividend ? They are growing at 40%-50% and ROE is 20%. Ideally, they should be paying very less/no dividend and ploughing back the money into business.

d) The ROE and ROA have consistently come down from fy09. Is it because of them coming out of the gold loan business ? I understand earlier they were having gold loan business and now they have come out. Is my understanding correct ?

e) Is the profit per employee Rs86000 only ??? Holy crap - There should be hiring freeze here and some firing too (like a software company :slight_smile: )

f) Is leveraging Muthoot fincorp branches is actually such an advantage. In most new towns they enter, they will have to first build relationship with the two wheeler showroom/company, then they can sell their loans. This is the first big step as I see it. My understanding is that customers can then utilize the fincorp branches for paying back the loan/emi.

g) I donā€™t understand much intricacies of banking, but did not see provisioning coverage ratio for NPAs ???

h) Given that very low value of loans (around rs 40000) Is there any case for arbitration and going to courts for seizing of vehicles. They may have to pay significant percentage ( 5-10%) of the loan as lawyer fees.

h) are they planning to get into other financing - like tractors, home loans given their reach ???

Hi Ananth,

Like your approach and logical questioning style. Please wait for the Management Q&A to come out. Unfortunately I am caught in some very urgent work on multiple fronts - and then we had the unnecessary diversions for couple of days - occupying much of my time in defense. So this will have to wait for a few days till I finish transcribing from my scribbled notes- the entire 6 hr+interviews.

Ananth - have you introduced yourself in the Expand your circle intro thread. If not please, do. And where are you based, etc. You may be able to add good value to Team ValuePickr efforts.

I wish and hope everybody adopts this simple logical way of questioning data/interpretation put up by us. So many smart guys I know at VP remain caught in pardon me - Intellectual Traps - keep parroting stuff like re-rating, multi-bagger, high ROE, good cash flows, ethical promoter - and I never really see them meaningfully dissect new stock ideas with merit - with any consistency:(.

Some folks say (in defense) they donā€™t have enough time - being in full time jobs - but hey some guys are spending considerable time - morning and evening at the site - commenting similar stuff - a lot in each others Portfolios endlessly - essentially the same kind of comments - I donā€™t see any growth in these guys over the last 6 months, a year or 2 years - such a pity - such a waste of talent:(.

After the initial reading up - where you form the essential concepts and your comments - on the same stuff - re-rating, multi-bagger, high ROE, good cash flows, ethical promoter etc - which are good stuff in abeginners arsenal - its time to step up - dive deep in atleast 1 emerging business - have the aim of becoming the go-to-guy on that business fro everyone at VP - which means you have on your finger-tips whatever is publicly known about the company, and are ahead of most folks on new developments and/or facts/nuggest of additional layered info - 2nd or 3rd level of detail that most folks dont know or care to dig enough - but that is the superior edge you have in the business.

I can honestly say - except for an Omprakash (Kaveri, Avanti, Shilpa fame) or a Vinod MS (Kaveri, Canfin, Muthoot fame) I havenā€™t really seen any of next-gen ValuePickrs stepping up - growing from what they are/were 6 months, 1 year back. They are now adding solid value - but there are atleast 10 other names I could take who showed promise n potential - n great style (like Rohit Sharma till recently, in Cricket) but execution ability remains poor - for (I suspect) not going the distance in hard work, discipline, following the leads/hints that seniors provide about the process of growing up! Its not about time at your disposal, its about your passion about getting better at the game each day!

Ok - enough of pet themes and rants - what will be will be :slight_smile:

Cheers

Hi Team,

MCS story is framed vey nicely ,thanks to donald for such extra effort and Ayush for bringing this script into highlight.

I have some questions

  1. They are into consumer and Commercial Finance , why most of the revenue is from consumer finance and that too from 2W space?
  2. Most of the company are taking deposits ,its easy for MCS to raise fund through this and how its different from taking loan from bank and lending?
  3. Automation in Loan Origination System (LOS) will be implemeted by Muthoot Fincorp right? Now if they are sharing this with MCS will company will be paying money or extra royalty to Fincorp.

Thanks , V

Ananth has covered a lot of ground with his questions.

I have a few questions to ask

  1. Can we get a sense of the customer profile?

Isnā€™t 28% too high a rate to borrow money at. Persons with regular income stream will get a bank loan at a much lower rate. Profile of a typical muthoot customer would help us understand the potential market size and the risks involved.

I think the management Q&A will provide more clarity here.

  1. Manpower

The Business in general is manpower intensive. NBFCs have very little influence on the customer. There is a huge dependency on the Dealerā€™s sales team to refer cases. 2-Wheeler customers expect very quick disbursal and so Dealers insist on manpower presence at the dealership.

A rough estimate, gives me around 95000 cases last year. If I take 1000 frontline employees ( 100 Out of average employee count of 1886 is a very low figure), We get 9-10 cases per employee per month.

My sense is a sales people in a CV financier would do about 5-7 vehicles a month. This should be higher for 2-wheeler considering the higher volumes, low ticket size etc

Employee productivity from a salesforce perspective would be much more important than the back end IMHO.

hi

presently muthoot is present in 2-3 wheeler financeā€¦

the potential of growth in loan book is always calculated with respect to the increase in shareholders fund over the year keeping capital adequacy ratio constant.

simple calculations tell me that if the company earns abt 20 cr per year, it can lend its loan book(aum) by only 100 cr keeping capital adequacy(car) at 20%(now)ā€¦that means from 600 cr amu to 700 cr amu(only 15% growth) if adequacy ratio is maintainedā€¦hence i dont see aum growing above 20% unless car dilutedā€¦hence may be a rights issue will be soon on the cards.

i wont be surprised if it ventures into truck finance and sme/commercial finance as the likes of shriram transport finance and shriram city union financeā€¦these would come up once the company scales up its reserves/shareholders fund because that would require more networth to keep the adequacy ratio in lineā€¦

i never feel that growth is an issue ever for finance/home loan/banks etcā€¦because money is ever in demandā€¦the issue is with what margins the growth is attained along with how npa levels are managedā€¦

once networth expands we will surely see new financial products from muthoot capā€¦may be a rights issue will help them raise the shareholders fund to tap the market fastā€¦

hi

presently muthoot is present in 2-3 wheeler financeā€¦

the potential of growth in loan book is always calculated with respect to the increase in shareholders fund over the year keeping capital adequacy ratio constant.

simple calculations tell me that if the company earns abt 20 cr per year, it can lend its loan book(aum) by only 100 cr keeping capital adequacy(car) at 20%(now)ā€¦that means from 600 cr amu to 700 cr amu(only 15% growth) if adequacy ratio is maintainedā€¦hence i dont see aum growing above 20% unless car dilutedā€¦hence may be a rights issue will be soon on the cards.

i wont be surprised if it ventures into truck finance and sme/commercial finance as the likes of shriram transport finance and shriram city union financeā€¦these would come up once the company scales up its reserves/shareholders fund because that would require more networth to keep the adequacy ratio in lineā€¦

i never feel that growth is an issue ever for finance/home loan/banks etcā€¦because money is ever in demandā€¦the issue is with what margins the growth is attained along with how npa levels are managedā€¦

once networth expands we will surely see new financial products from muthoot capā€¦may be a rights issue will help them raise the shareholders fund to tap the market fastā€¦

last time when book value was at 40-45ā€¦rights came at 80 to shore up the shareholders fund to tap growth(loan book depends upon networth of finance cos)ā€¦this time book value would be touching 90-100ā€¦if rights comes within a yearā€¦it would be around 150-180ā€¦if laterā€¦then price would differā€¦

Two wheeler financing business appears to be a highly competitive one with too many players. New players are also jumping in aggressively here.
Iā€™am not sure it is worth betting for long term in this sector.

HDFC bank, SCUF and Indusind bank are the three top players in two wheeler financing.

SCUF became the second largest player here recently

Some Important points from above link:

companyā€™s assets under management of Rs 15,928 crore as of December 2012, two wheeler loans account for Rs 1911.36 crore or 12%.
She also said the company expects two-wheeler loans to grow 20-25% annually.

Hinduja finance gets aggressive into two wheeler financing.

Honda tie up with L&T finance

http://www.indiainfoline.com/Markets/News/Honda-Motorcycle-and-Scooter-India-ties-up-with-LandT-Finance-Holdings-for-2-wheeler-loans/5858437431

Two wheeler financing very low in urban area

2012 article - Hero ties up with HDFC bank.

Look at the interest rate in this 6.99%. How come Muthoot charges 28% ???

SCUF charges 22-26% interest rate for two wheeler financing and has got CAGR of 40% in last 3 years in two wheeler financing.

http://content.icicidirect.com/mailimages/IDirect_ShriramCityUnion_MgmtNote.pdf
http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=2999797

Question is how will Muthoot combat SCUF when they expand in other states in south india ?
Doesnā€™t SCUF look a better bet if at all one has to bet in this space ?

I get a sense that these financiers are charging a high interest rate for non salaried people. Banks may not get in this space.
what is the breakup of non-salaried vs salaried for Muthoot ? It may be worth finding the same for SCUF (especially in two wheeler financig)

Some insights into two wheeler financing business from SCUF.

http://www.aceanalyser.com/Conference%20Call/132498_20140130.pdf

a) Two wheeler financing is very profitable. Most of the growth in the two wheeler finance business is coming from non-south regions. There is no much competion here particularly north. These branches were opened in 2009-2010 (sales folks getting more experienced) are now seeing good traction in two wheeler financing.

b) south is consolidating particularly andhra.

c) Loan duration mostly 2 years vs 3 years in MSME.

d) Trend of more people are opting for vehicle financing instead of going for direct cash sale seen in two wheeler.

e) EMI in two wheeler financing is around Rs1800 pm. Cannot not ask for property as security.

Just few observations

  1. Agree with 100% with observations made by Ananth and those are very very important questions.

  2. Avg interest yield is around 28%. Now I am sure one can borrow at a lesser rate using credit card or taking personal loan. For people with own house why not bank will be willing to give loan at much lesser rate.

  3. Submission of house document does not mean company will have any lien on house. Yes it definitely means that person taking loan is definitely of much better credit rating. But WHY a person with OWN HOME take merely 40,000 loan that too at 28% interest rate.

  4. Is the NPA lower because they are lending to people with own home. Can they growth at 25% for next 5-7 years sticking only to this segment of customers. I thought generally people below middle income level like person working in Pizza hut might be taking loan for 2W and that person might not be having Own home.

  5. Some where I read approximately 30% of 2W are sold on loan. My Guess is % of people taking loan for 2W with OWN home might be very less.

  6. LetĆ¢s agree for time being that they can grow at 25% for next five years. Why not banks & other NBFCs will get more aggressive. Secondly if they have to grow at 25% + for next five years, definitely they will be taking some market share from existing players and mostly it should be unorganised segment. Is unorganised segment big enough that they can grow by taking market share from them. [I am implicitly assuming that it will be very very difficult for them to grow taking market share from existing organised players. Unless and until they promise higher incentive to 2W dealers they will not change their existing finance partner. For most of the 2W finance, I will guess presence at sales point will be very important. So we might need to find out MC plans in this respect]

  7. NPA numbers appears to be too good to be true. There are many ways in which NPA numbers can be distorted. By writing off loans as soon as they become NPA, giving top up loans etc. Recall what happened in Mannapurram. For SCUF GNPA between June-12 to Sept -13 was between 3-4%. Moreover, NPA might be low base or recent expansion in AuM. Not doubting the integrity of management, but one need to take these low NPA numbers with extra care. Moreover this segment commands higher interest rate because NPA are higher and customer credit profile lower.

In summary big concerns are a) Competition, which might impact the yield b) Growth Ć¢ taking market share or loosing credit standards. Why someone should come to MC if some other NBFC or bank gives lower interest rates. Customer with own house are premium customers in this category. C) Substitution threat from other similar products like credit card finance or personal loans at much cheaper rates.

Hi Anil,

a) Competition was, is and will always be there. The bet is that ā€˜need for moneyā€™ at ā€˜convenience, location, speedā€™ is ever-lasting and an ever-increasing pie. I think presence in the remote-est locations of Kerala in itself is a strategic advantage. If competition is really a concern, say in personal loans, there would not have been so many banks offering loans at similar rates (where they can easily cut a few 100 basis points for ā€˜premiumā€™ customers across all cities but have not done so), and still growing their personal loan portfolio y-o-y. There is something of a consumer hunger and I personally think competition is not an issue from an yield perspective.

What is of concern surely is the competition penetration in other states and how MC can stay on, be competitive and also penetrate deeply for higher market share. That surely is a concern, unless Kerala market is extremely 2W hungry for a long time.

b) Since we are talking of the unorganized market, credit cards/personal loans from Banks wouldnā€™t work (as in, Banks havenā€™t offered to this sector historically, and as recently as today (checked with a cousin who is a credit officer in a big bank). Even an employed person in Bangalore, with say Rs.20K per month take home salary got only Rs.40K as credit limit (from ICICI). Aaj kal, every bike is upwards of Rs.50K.

I think the primary questions on MC according to me are -

a) Whether they can increase their market share in other states and

b) If Hero/Honda have already started their own financing scheme and how they plan to counter it.

I have no particular insight edge in the above two questions (apart from generic gyan). Had invested in this a while back and got out. No plans to invest now. People who have a greater insight/nuanced insight obviously would have invested.

P.S: Iā€™d be very curious at how they would dilute again shortly. They diluted at 1x book through a rights issue last time and promoter participated in it. I am unsure if market would accord this higher valuation if the promoter dilutes it again at 1x book.

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