Geojit Financial Services has issued an "Accumulate" rating on Muthoot Finance, with a target price of Rs. 2,140. Muthoot Finance, India’s largest non-banking financial company (NBFC) specializing in gold loans, is expected to see a compound annual growth rate (CAGR) of 16% in its loan assets under management (AUM) from FY24 to FY26. Key growth drivers include rising gold prices, branch expansion, and reduced competition. Despite lower yields in the gold loan segment, Muthoot is projected to deliver a 19% CAGR in profits over FY24-26 due to operational leverage and an improving return on equity (ROE). Geojit’s valuation underscores Muthoot’s premium positioning, backed by robust asset quality and conservative policies.

Investment Highlights

Strong Loan AUM Growth Expected
Muthoot Finance’s loan AUM is projected to grow at a CAGR of 16% between FY24 and FY26, driven by increasing gold prices, reduced competition, and a decline in unsecured lending due to rising credit risks. This growth will be supported by an expanding branch network, with the company planning to add 150-200 new branches each year.

Yields to Stabilize, Profit Growth at 19% CAGR
The company’s yields are expected to stabilize at approximately 18%, aided by reduced competition in the gold loan sector. Despite lower yields, Muthoot anticipates a 19% CAGR in profits for FY24-26, driven by higher AUM and improved operational efficiency.

Branch Expansion Fuels Customer Acquisition
Muthoot Finance plans to add between 150 and 200 new branches annually, which will facilitate loan growth and customer acquisition. The company currently operates over 6,759 branches across India, and this scaling strategy will further enhance its market penetration.

Asset Quality and Conservative Auction Policy

Higher Provisions for Conservative Risk Management
Muthoot Finance maintains higher provisions than its peers due to its conservative auction policy, which is designed to preserve customer relationships. This approach, coupled with a lower loan-to-value (LTV) ratio (~63% as of Q1FY25), helps to mitigate asset quality risks. Furthermore, rising gold prices provide additional support to the collateral value.

Valuation and Target Price

Premium Valuation Justified by Strong Fundamentals
Given the stability of gold as an asset class and the expected improvement in ROE by FY26 (projected to reach 19.1%), Muthoot Finance merits a premium valuation. Geojit Financial Services has set a target price of Rs. 2,140 for Muthoot based on a sum-of-the-parts (SOTP) valuation method, which values the consolidated entity at 2.4x FY26E BVPS. This valuation is above the five-year average of 2.3x, reflecting the company’s strong growth prospects and financial stability.

Key Financial Metrics

Attractive Return Ratios
Muthoot Finance’s return on equity (ROE) for FY24 stands at 18.1%, with an expected increase to 19.1% by FY26. The company’s return on assets (ROA) is also strong at 5.1% for FY24, with a projected rise to 5.5% by FY26. These attractive return ratios underscore the company’s ability to deliver robust shareholder value.

Strong Capital Adequacy Ratio
Muthoot’s capital adequacy ratio (CAR) is well above regulatory requirements, standing at 30.4% as of FY24. This strong capital position provides a buffer against potential risks and supports the company’s expansion plans.

Outlook for Gold Loan Business

Gold Price Rally Supports AUM Growth
The recent rally in gold prices has had a positive impact on Muthoot Finance’s gold loan business, with a correlation coefficient of 0.9 between gold prices and loan AUM growth. As gold prices rise, the value of collateral increases, reducing lenders’ risk exposure and allowing borrowers to secure larger loan amounts. This dynamic is expected to drive AUM growth at a 16% CAGR over FY24-26.

Lower Yields to Attract Customers
Muthoot Finance has adopted a strategy of offering lower yields compared to its peers, which helps attract more customers in a competitive gold loan market. Although the lower yields compress margins, the company is able to compensate through higher AUM growth and improved operational leverage.

Risks and Concerns

Potential Risks to Gold Loan Business
Several factors could pose risks to Muthoot Finance’s gold loan business, including:

Gold Price Volatility: A significant decline in gold prices could reduce the value of collateral, impacting loan recoverability and increasing the company’s credit risk.
Regulatory Changes: Any adverse regulatory changes, such as revisions to the permissible LTV ratio or stricter guidelines for gold loan companies, could negatively affect Muthoot’s business model.
Competition from Banks: Banks, with their lower cost of funds, could pose a competitive threat to NBFCs like Muthoot by offering lower interest rates on gold loans.