Gold price & gold loan NBFCs – Is the correlation breaking down?
All through the last 10 years, there has been a simple linkage between gold price and the perception of performance of gold loan NBFCs. If gold prices went up, stocks of gold loan NBFCs like Muthoot & Manappuram would do well and vice-versa if the prices went down. This simple correlation was based on the understanding that if gold prices go up, loan growth improves, operating leverage kicks-in, auctions reduce and profitability improves.
Thumb rules work, till they stop working: The above-mentioned correlation seems to have broken down in last twelve months. The stock prices of Muthoot and Manappuram have been weak despite the 10% improvement in gold prices and the improved outlook for gold (due to inflation and the war related uncertainties). One can argue that the weak performance of these stocks could be due to the muted growth & high auctions in the past 2-3 quarters. But one can immediately counter argue that stock prices are more reflective of what can happen in the future and that future growth prospects for gold loan sector looks bright given the firmness in gold prices and opening up of Indian economy. What then explains the underperformance?
Competitive intensity is the joker in the pack: Over FY15-20, retail gold loan sector was growing at mere 8-10% CAGR and accounted for less than 1% of India’s total outstanding loans. This coupled with operationally intensive nature of gold loan business ensured that most banks stayed away from this segment and specialized NBFCs were able to not only grow well but also improve their profitability to remarkable levels.
| Muthoot Finance | Mar-16 | Mar-17 | Mar-18 | Mar-19 | Mar-20 |
|---|---|---|---|---|---|
| Loan book (bn) | 243 | 272 | 288 | 366 | 408 |
| RoA | 3.4% | 4.4% | 5.9% | 5.6% | 7.4% |
| Manappuram | Mar-16 | Mar-17 | Mar-18 | Mar-19 | Mar-20 |
| Loan book (bn) | 66 | 91 | 100 | 116 | 205 |
| RoA | 3.3% | 6.0% | 4.6% | 5.3% | 6.6% |
This goldilocks scenario seems to have been disturbed with many new players entering the gold loan arena. As we can see from the table below, relatively new entrants like SBI, CSB, Federal Bank, Fed Fina, etc have created decent sized gold loan portfolios. To add to this, there are players like ICICI Bank & Bajaj Finance who have also joined the bandwagon but do not report the gold loan AUMs separately.
| Loan book (bn) | Mar-19 | Dec-21 | Increase (x) |
|---|---|---|---|
| Incumbents | |||
| Muthoot Fin | 336 | 542 | 1.6 |
| Muthoot Finorp | 130 | 205 | 1.6 |
| Manappuram | 116 | 205 | 1.8 |
| IIFL | 63 | 146 | 2.3 |
| Incumbents | |||
| SBI | 14 | 221 | 15.8 |
| CSB | 30 | 58 | 2.0 |
| Fed Bank | 17 | 54 | 3.2 |
| FedFina | 4 | 21 | 4.8 |
| DCB | 5 | 16 | 3.2 |
Lending yields are currently under pressure: Until 2020, it was believed that banks will not venture into gold loan business meaningfully due to operationally intensive nature of the business. But given that most lending avenues were running dry post IL&FS crisis in Sep18, many banks have started to look at this niche and highly profitable lending segment. While SBI & CSB rely on internal resources to run the gold loan business, Federal Bank, Karur Vysya and ICICI Bank have entered into symbiotic relationship with start-ups like Rupeek & Indiagold to do the front-end for them.
| Yield | Mar-20 | Mar-21 | Dec-21 |
|---|---|---|---|
| Muthoot Fin | 23.0% | 22.2% | 20.6% |
| Manappuram | 25.4% | 24.9% | 20.3% |
| IIFL | 19.4% | 19.1% | 17.4% |
All this has resulted in price war between banks & NBFCs and within NBFCs too and yields for NBFCs have been under pressure. At the peak of the price war in Sep’21, many banks and NBFCs were offering large ticket gold loans at 6-8%!
Is the damage temporary or permanent: Stock prices of Gold loan NBFCs look cheap even if one looks at them on TTM P/E ratio. The subdued stock prices for Muthoot and Manappuram despite attractive valuations seems to be Mr. Market’s message to investors – “competition is here to stay, the best of lending yields & profitability are behind us, let us wait and watch as to how much lower do the settle”
1. Muthoot Finance is the gold standard in gold loan segment with best-in-class brand, liability profile and operating cost structure. While there is little doubt that it will remain the leader in the coming decade as well, but profitability (RoAs) over the coming years will probably settle at 100-150bps lower vs FY21 levels. Competition in 2lac+ ticket size is here to stay as a leader, Muthoot will have no option but to keep fighting in this segment. The less than 1lac ticket size represents a large & profitable opportunity, but the branches have to keep running to maintain & grow this part of the loan book.
2. Manappuram Finance has a much tougher job at hand. Its higher operating costs (2x v/s Muthoot) will not allow it to compete in the 2lac+ ticket size and it will have to do the hard work of originating smaller ticket sized loans, where yields are still upwards of 18%.
3. IIFL Finance is somewhat in a sweeter spot because it never had sky high RoAs in the first place. And the old branches have reached critical mass needed to keep operating costs low.
Make no mistakes that this is not a start-up driven disruption. The gold loan start-ups continue to burn money and are yet to come up with any path-breaking innovation on any aspect of gold loan business. The competition seems to be from banks in general and in some cases, the symbiotic partnership between start-ups and banks.
The bull, bear & base cases: The bull case for gold loan NBFCs seem to be that the competition is temporary and we will see a sharp bounce back in growth & profitability. The bear case represents sustained increase in competition and 2-to-3-year period of yield compression. In that case, multiples will de-rate further unless they are able to diversify into new areas of lending. The base case is that the profitability adjustment phase ends in a few quarters, RoAs will settle around 5-6% range, and there is enough room for everyone to grow at 10-15% CAGR. In this case, the stocks will continue to underperform / consolidate. Currently, we are neither in the bull or the bear camp and will stick to the base case.
Note: The data used above has been taken from company presentations or annual reports. We would like to thank our friends working in gold loan industry for helping us decipher the trends and plugging the gaps in our understand. If you have any observations on the above article you write to us on [email protected]