Traditionally, gold loan companies are thought of as NBFCs. But lets look at them from a slightly different perspective – as pawn brokers, which they are in a sense. What customers are doing is pawning their gold ornaments / jewelry and taking a loan against that.
There is minimal risk of losing money on the loans for the gold loan companies, especially in an environment of increasing gold prices. The loans are of small quantum (average INR 40k) and short tenor (3-6 months). In case of default, the collateral can be easily sold to recover the principal as well as interest. The LTV of the gold loans is regulated by RBI and is currently at 75%. For Manappuram and Muthoot, current LTV is 59% 1 and 53%2 respectively. Additionally, these are strong businesses with very high profitability and are protected by strong moat. So if there is very little risk of losing money, then it is better to thing of these companies as pawn business instead of as an NBFC. If that is the case they should be valued on P/E basis instead of P/B, unlike other Banks/ NBFCs.
Last two years have been very good for both Muthoot and Manappuram. Muthoot’s assets, revenues and profits have increased at CAGR of 21%, 14%, and 23%. For Manappuram, these numbers are 30%, 26% and 47%. However, I believe the future is brighter for both the businesses and their best years are ahead of them. They have a tailwind in terms of increasing price of gold. But, the coming few years are going to be a period of economic slowdown. And times of distress, pawn shops do very well as consumers need money. And for this section of the consumers, their only option is usually gold loan companies. That will be especially true in the current scenario as banks / NBFIs become more cautious.
During the previous financial crisis, both Manappuram and Muthoot did very well. During FY2008-12, gold prices increased at a CAGR of 17%. During the same period, Manappuram’s and Muthoot’s AUM increased from 565cr and 2,179cr to 11,600cr and 24,400cr at a CAGR of 113% and 83% respectively. Even in the US, pawn shops’ business model are considered resilient during economic downturns. If this is indeed true, we will see growth in the loan books and profits for both gold loan companies in the coming quarters, while the Banks and NBFIs will struggle with increasing NPAs and stagnant or negative growth.
So, in my opinion Muthoot and Manappuram are just getting started and the conditions are ideal for their continued outperformance. As the market realises this, they will get rerated. They should experience the double benefit of increasing earning and multiple expansion.