Can Manappuram Finance shares jump 100%? Yes, says Ambit

Gold loan firm Manappuram Finance could turn out to be as good as gold for investors who are willing to be patient, according to a report by Ambit Capital.

The company’s earnings per share have expanded at a compounded annual growth rate of 80 percent over the past five years and its return on equity has been maintained at a steady 25 percent. That, despite the fact that its cost of funds went up by 400 basis points (100 basis points = 1 percentage point) over the same period.

But after the Reserve Bank of India introduced curbs on theloan-to-value ratio for gold loan companies**,**the stock began tanking. (LTV is calculated as a percentage of the loan to the value of gold jewellery kept as collateral. If a borrower keeps gold jewellery worth Rs 100,000 with an non-banking finance company, he or she will be eligible for a maximum of Rs 60,000 as loan from the company.)The stock has plummeted a steep 66 percent in the past three months, and is currently trading at a discount to its book value.

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Here are five reasons why Ambit Capital believes now is a good time to buy the stock:

1. Corporate governance: The RBI has reprimanded Manappuram Agro Farms for using the finance firm’s premises to collect money. While Manappuram initially denied all charges, Ambit says that in subsequent discussions with the management, Mannapuram accepted the phenomenon as a failure of corporate governance and assured that adequate steps were being taken to rectify the issue. The bank has now completed the process of segregating the listed entity with other promoter entities, which underlines the fact that enough measures have been taken to move beyond the issue of corporate governance.

2. Managing liabilities: Even after the RBI removed gold loans from the list of priority sectors last year, Manappuram has been able to grow its loan book by 90 percent. However, sector issues have made fund-raising difficult for the company.

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 The RBI also had asked banks to reduce their exposure to a single gold-loan company to 7.5 percent from 10 percent of their capital funds. Once Manappuram sorts out its corporate governance issues and improves its fundamentals, it will be able to handle its liabilities, predicts Ambit.

3. Impact of LTV: The RBI had capped the loan-to-value ratio for gold loans at 60 percent at a time when the average LTV of Manappuram was 75 percent. That has two implications: lower loan growth as well as some customers shifting to the unorganised sector to secure higher loan amounts.

Ambit says that while the super-growth period of Manappuram may be over, it will still be able to show loan growth of 18-20 percent per annum once the impact of lower LTVs filters through in the next 12 months.

The firm expects its net interest margins (the difference between cost of funds and loan rates) to decline by 280 basis points to 11.5 percent in 2012-2013 from 14.3 percent in the quarter ending December 2011. In comparison, a non-banking finance company like Shriram Transport has net interest margins of 6-7 percent, Ambit says.

4. Operational efficiency: Despite the fall in net interest margins (NIM), enhanced operational efficiency will offset, to some extent, the adverse impact of falling NIMs, notes Ambit. Manappuram, which spends heavily on advertising, can easily lower advertising costs if loan growth takes a steep dive. The company also keeps its branches open seven days a week. Closing branches one day per week will bring about a 10 percent saving on Manappuram’s per branch per employee cost, says Ambit. In other words, there is room to cut costs and buoy NIMs.

 Ambit expects the company to deliver a 3.5 percent return on assets in 2012-2013 and 3.6 percent in 2013-2014. Return on equity is estimated at 18 percent for each year.

5. Valuations: While the company will suffer declines in margins and loan growth, there is a buying opportunity since the stock is trading at a 25 percent discount to its 2011-2012 book value (value of assets). That valuation almost implies winding up of the company, which Ambit says is highly unlikely.

Even if the return on equity falls to 15 percent, the stock, compared with peers, must trade at least at book value. Ambit values the stock at Rs 46, implying a 100 percent from current levels.