MUTHOOT CAPITAL SERVICES

Background

Muthoot Capital Services Ltd. promoted by Muthoot Pappachan Group is a deposit taking Non Banking Finance Company (NBFC) registered with the Reserve Bank of India and listed on the Bombay Stock Exchange. 

Established in 1994, Muthoot Capital Services Ltd offers vehicle loans – primarily 2 wheeler and 3 wheeler loans.


Main Products/Segments

Muthoot Capital AUM (Cr)
9mFY14
GNPA
Q3FY14
Sales (Cr)
9mFY14
 Contrib
%
2 Wheeler 504.54 1.01% 386.46 96%
3 Wheeler 105.41 4.86%    6.57 4%
Blended 609.95 1.68% 403.03
Muthoot Capital FY09 FY10 FY11 FY12 FY13 9mFY14 FY09-FY13
CAGR
AUM (INR Lacs) 7167 9669 17184 29578 45569  60995  58.79%
Disbursements (INR Lacs) 1044 4285 13835 28845 43117  40316  153.53%
Avg Lending Rate 24.25% 28.81% 28.74% 28.39% 28.79% 27.09%
Avg Borrowing Rate 10.72% 11.01% 11.08% 11.92% 12.83% 12.39%
NIM 13.53% 17.80% 17.66% 16.47% 15.96% 14.69%
Avg Loan Size (INR) 33405 33315 39391 43351 45139 42502 7.82%
Gross NPA 0.94% 0.81% 0.63% 0.26% 1.00% 1.84%
Net NPA 0.73% 0.63% 0.52% 0.20% 0.87% 1.61%
RoA 9.32% 8.43% 6.85% 6.24% 5.50% 3.89%
RoE 38.29% 38.29% 38.27% 26.71% 22.92% 19.51%
Cost to Income Ratio 0.44 0.38 0.39 0.42 0.45 0.46
Capital Adequacy Ratio 21.12% 20.86% 16.48% 28.56% 21.71% 19.61%
Total Customers 4343 15393 46589 99647 118568 212682 128.58%
Avg Monthly Disbursement 260 1072 2927 5545 7960 10540 135.23%
Salary Costs/Op Income 5.05% 11.15% 13.84% 18.22% 20.39% 21.90%
Sales (INR Lacs) 1712 2239 3770 6701 10664 11235 57.98%
PAT (INR Lacs) 542 717 967 1551 2176 1626 41.55%
Total Employees 55 207 505 1034 1626 2146 133.18%
Avg Employee Count 131 356 770 1330 1886
Sales/Avg Employee (INR Lac) 17.09 10.59 8.70 8.02 5.96
PAT/Avg Employee (INR Lac) 5.47 2.72 2.01 1.64 0.86

Source: Company

  • Group Branch Network: 3800 Fincorp branches -currently as cash payment collection points
  • Operations Network: 29 Hubs; 8 MCS owned and 21 shared premises with Fincorp
  • Dealer Points: – 1200 @2-3% commission; Usually 1 Customer Sales Executive (CSE) at dealerships
  • Disbursements Concentration 9mFY14 (FY13): Kerala 54% (60%), Tamilnadu 15% (14%), Andhra Pradesh 10% (9%), Karnataka 16% (13), Goa 0.6% (0.6%), Gujarat 2% (1.5%), Mahrashtra 2% (1.5%)
  • Group Customer Base: ~3.2 Mn Fincorp customers; Not much active cross-selling at the moment because of absence of unified database. (planned availability FY2015)

Main Markets/Customers

  • Strong Kerala Presence statewide – 20-25% market share. Competes strongly with IndusInd Bank and HDFC Bank. No#2 in Kerala just behind IndusInd Bank. Total Kerala market ~40,000 vehicles financed per month.
  • Muthoot Fincorp branches in Kerala are pretty much all leveraged by MCS. Fincorp has 900 branches in TN and around 600-700 branches in AP and KN each which leaves lot of space for leveraging on.
  • Nascent presence in Tamilnadu, Karnantaka, Andhra Pradesh (historical stronghold of Shriram City Union Finance?). These 3 states are traditionally huge markets for 2Wh financing. The company plans to grow Sales substantially leveraging existing Fincorp branch strength (without incurring much by way of fixed costs) – which is pretty entrenched in these 3 states.

Bullish Viewpoints

As on Mar 2013/
Dec 2013
Muthoot
Capital
SCUF SHTF Chola Sundaram MMFS Bajaj Finance
Size (AUM Cr) 610  15800 49700 19000 17600 27900 17100 Dwarfed when compared to Industry
Years in Business
(Effectively)
20
(6)
28 (11) 35 36 60 23 27 Miles to go before proving itself
Capital Adequacy 19.61% 23.3% 19.9% 17.1% 17.7% 19.1% 20.9% Adequate; may need replenishing
3Yr Earnings CAGR 50% 45%  19%  74%  20%  39%  58% Robust growth
Cost to Income 46% 37% 26% 50% 37% 33% 45% High
Cost of Funds 13.10% 12.6% 9.8% 10.6% 10.6% 9.9% 10.3% Industry Highest
Employee cost/Avg no of Employee (Lacs)  1.66  1.75  5.36  12.19 Industry Lowest
Business Size/Avg no of Employee (Lacs)  38  92  385  553 Industry Lowest
Margins 14.69% 11.2% 7.0% 7.6% 8.4% 9.4% 12.1% Industry Highest
Yield 27.4% 22.1% 16.3% 15.4% 17.7% 16.4% 20.7% Industry Highest
Gross NPA  1.68%  2.4%  3.2%  3%  2.5% Industry Lowest
RoA 3.89%  3.2%  2.9%  2%  3%  3.4%  3.6% Industry Highest
P/B (CMP 87) 0.88   2.2  1.8  1.5  2.4  3.05  1.6 Attractive
P/E (CMP 87) 4.57   12.7  10.37  10.6  15.14  14.35  11.24 Attractive

Source: Company, Annual Reports

  • High Growth – Earnings have grown at an impressive 50% CAGR over last 3 years next only to Bajaj Finance – albeit on a much lower base. There is huge headroom to grow -provided the funding constraints get adequately addressed.
  • Highest Yields & Margins in the Industry – Again despite a declining trend, Margins (14.69%) and Yields (27.4%) for 9mFY14 are the highest in the industry, although on a much lower base compared to bigger competitors.
  • Highest Profitability in the Industry – Even with a declining profitability trend over last few years, MCS RoA at 3.89%  (9mFY14) is the highest in the industry. With the steps Management has been taking, RoA looks set to improve in near to medium term.
  • Stringent Credit Policy – As per the Management the primary reason for its strong showing and low NPAs is very strict adherence to the robust and detailed credit policy laid down by the company – extensive covering of different models and different customer segments (salaried, income-based, Asset-based, or NO docs financing with higher down-payments). Different Loan to Value (LTV) levels apply for different customer segments.
  • 85% of Loans backed by “Own House” documents – This is probably unique to Muthoot Cap that 80-85% of its disbursements follow asst-financing model – loan to folks with own-house document proof – either the borrower or the guarantor (usually close relative). This helps the company in collection/recovery process – as borrower is reluctant to run the risk of property attachment in case of default – especially for small loan sums < Rs 40,000.
  • Lowest NPAs in the Industry – Gross NPAs at 1.68% is the lowest in the auto-financing industry. All auto-financiers including Bajaj Finance have been seeing a spurt in NPAs in recent quarters. MCS has been managing the NPA situtation admirably. Collection Executives are focused on bringing down the ~15.75 Cr of likley NPAs substantially down by 31st March 2014 or, Gross NPAs to <1.5% or less. Senior Management is focused on closely monitoring stressed A/Cs (likely to become NPAs) and Collections on a daily basis.
  • Extreme Focus on write-offs recovery – MCS is again probably unique in its focus of trying to ensure recovery of every rupee that is written off. Post Arbitration (company has appointed arbitrators) 3-4% of cases vehicles are repossessed and sold off. Cases are filed and in due course company is confident of recovering loan amounts due along with legal costs and charges.
  • Big Productivity Improvements likely in FY15 & FY16 – With enterprise-wide automation being introduced and Profit Center benchmarks being established, company is embarking on a productivity linked budgeting exercise from FY15 onwards. Management opines this will help the company monitor income and expenses more granularly and modify policies for getting the best productivity – locations-wise and team-wise.
  • Cross-selling within Fincorp customer base – Fincorp has a customer base exceeding 3.2 Mn Customers today. Effective cross-selling may become possible once Fincorp group database becomes available (post automation) in FY15 and may provide a kicker to Sales growth.
  • Attractive Valuations – MCS is currently (CMP 87) trading at a discount to Book and ~4.5x PE with a 4.8% dividend yield – which looks reasonably attractive.

Bearish Viewpoints

  • Declining profitability trend – While 5 year Sales or Profit CAGR may look healthy, and FY14 Sales may register 40%+growth, FY14 PAT is likely to register flattish or negative growth. Return on Assets (RoA) have consistently declined and halved from ~9% levels 5 years back.
  • Employee Productivity bottleneck – If we examine the reasons, what strikes immediately is the nearly ~3 to 5-fold drop in Sales and Profitability per employee. The situation has got accentuated on 2 fronts. First, disbursements didn’t keep pace with recruitment leading to under-utilisation. Company was doing ~60 Cr disbursement by Mar 2013, but in 9MFY14 has managed to disburse only ~400 Cr. Secondly there is enormous duplication of excel-based data-entry work between Operation Hubs and Back-Office in the absence of enterprise-wide automation. Company has been cognizant of the second front and has been working to introduce fully-automated Loan Origination System covering Sales, Operations and Credit processes from April 2014 -planned to be fully operational by end of Q1FY14.
  • Delay in Bank Funding – Disbursements have been hampered by delayed funding availability from Banks. Typically Bank Limits are enhanced based on the current Balance Sheet. The BS gets ready by April/May with Banks taking another 2 months. So while company had a disbursement run-rate of 60 Cr by Mar 2013, it could disburse only ~40 Cr in Apr-Aug’2013 (up to 50-60 Cr for Sep-Dec’13) despite otherwise having ready sales/operations personnel – leading to under-utilisation. In earlier years this hadn’t proved a bottleneck (probably shareholders equity sufficed for first few months till enhanced bank borrowings kicked in) but it certainly has impacted disbursements and profitability significantly in FY14. For FY15 Company expects to kickstart approval process with banks within Q4FY14.
  • Deteriorating 3 Wheeler Market/Portfolio – MCS 3 Wheeler Loan market (primarily Kerala) has been steadily deteriorating. Monthly Sales at 7500 vehicles is now down to 3500 vehicles per month. Reportedly daily earnings of 3-wheelers down to 450/- from Rs 850/- earlier. The 4 wheelers Tata IRIS/ACE has also started doing well. 3 Wheeler Associations have written to prominent vehicle finance companies to stop issuing 3 wheeler loans in Kerala. Debt servicing capability of borrowers is badly dented and gross NPAs are on the rise [~5% in 9mFY14]. However, 2 Wheeler gross NPAs remain firmly under control and are probably the best in industry at ~1%
  • High Cost of Funds – MCS Cost of Funds is the highest in the industry at 13%+. Dependency on Bank Funding is high and  current A (negative outlook) rating by CRISIL (clubbed with Muthoot Fincorp) isn’t helping either. Public NCDs/other options are probably restricted till a ratings upgrade is in place.
  • A (Negative Outlook) CRISIL Rating – While the reasons and rating sensitivity cited by CRISIL in its negative outlook are mostly attributable to the Gold Loan business of Muthoot Fincorp, declining profitability on MCS count has not helped either. Senior Management is strongly of the view that they have proven in last 6 years that MCS 2Wheeler/3Wheeler Auto Financing is a successful, sustainable, and scalable business model. They have moved out completely from the Gold Loan business. They deserve a standalone MCS rating which they feel merits much better rating – that may alleviate its funding constraints in a major way. Discussions are on with ICRA and CARE.
  • Single Product dependency – MCS product portfolio currently comprises of only 2 wheeler and 3 wheeler loans. With 3 wheeler NPAs rising company is consciously cutting back on 3 Wheeler loans. Dependency is very heavy on 2 wheeler loans. Any adverse developments in the industry/economy could significantly affect the company’s fortunes. Going forward the company has to look at product diversification for better risk-adjusted growth profile.
  • Funding constraints – Tier I & Tier II Capital – Currently Capital Adequacy stands at ~19% (Min CAR of 15% as per RBI). If MCS continues to grow at 40-50% rates, it will need capital infusion in the form of Tier I or Tier II Capital pretty soon. Raising Tier I (Equity Capital) is probably not an active option for the company (cf. current valuations). For Tier II Capital MCS has options of either going the route of Sub-ordinated Debt or Preference Capital – which may get decided based on Group liquidity levels in 2015/16.
  • Hero/Honda Company Financing – MCS is hugely dependent on financing for Hero and Honda 2 wheelers. In the event that either of these start their own financing arms – and provide preferential access to financing from their dealerships – MCS prospects can be affected significantly.

Barriers to entry

  • Unique/Flexible cash payment schemes – Customers can pay from any Fincorp branch anywhere in the country. A web-based collection module of MCS provides access to customer details and payment schedules, etc. for all Fincorp branches. Customers can choose to pay the monthly EMI say Rs 1500/-, in even Rs 200/- or Rs 300/- flexi-instalments. Fincorp collects 0.5% (up from 0.2%) as collection fees from MCS from FY 2013.
  • Leveraging widespread Fincorp network – With a growing pan-india network of more than 3800 branches – this is at the heart of the efficient collection system for MCS. MCS can simply piggy-ride this expanding retail network and does not really need to set up this infrastructure of its own as it scales up. MCS does not need branch offices as sales originate primarily from Sales Executives placed at Dealer Points. [Operational Hubs are required for managing every 30-40 Dealer points – where again shared (but separate) premises with Fincorp is the norm. Out of 29 Operational Hubs only 8 are MCS-owned including the Head Office location.]

Interesting Viewpoints

  • Started taking Deposits – MCS has recently started taking 1-3 year deposits at upto 12% rates through Muthoot Exim which acts as the broker. ~40 Cr deposits have been mobilised so far. The company seems confident of mobilising ~150-180 Cr (the max limit – 1.5x Net Owned Funds) within FY15. This will go way a long way in ensuring Margin Requirements with Banks and pave the way for enhanced Term Loans availability for the company.
  • Impending introduction of Automation – As per the company major automation in Loan Origination System (LOS) – covering Sales, Operations and Credit processes – is set to be introduced across all company Hubs and Offices in 1QFY15. Part of a much larger group automation project standard operating procedures (SOPs) have been defined by IBM in consultation with functional departments over the last 2 years. 3I Infotech is the major vendor and implementation partner. Apart from providing single-source unified MIS views, this is likely to bring in huge operational efficiencies and savings in FY15.
  • Muthoot Fincorp Sales Agency model – With Gold Loan business volumes coming down, Muthoot Fincorp has started proactively sourcing customers for MCS on commission basis (2%). Started only a year back, all Fincorp branch personnel have now been trained. With Muthoot Fincorp intrinsically incentivised (low Gold Loan Sales) this is expected to be rolled out to all 3800 branches in FY15 – reducing the dependency and large costs incurred by MCS on Sales Executives at Dealer points. Model is working well and expected to start delivering ~7500 vehicles (avg 2) a month.

Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months