Rising Competition And Regulatory Scrutiny Will Pressure Gold Loan Margins And Future Profitability

Catalysts

About Muthoot Finance

Muthoot Finance is a non banking financial company that primarily provides gold backed loans and related retail credit products through a large branch network in India and select overseas markets.

What are the underlying business or industry changes driving this perspective?

• Accelerating migration of better quality borrowers to banks and large AAA rated NBFCs, as digital gold loan products and lower cost funding expand, could compress Muthoot Finance's achievable yields and slow revenue growth over the medium term.
• Structurally rising competition in core southern markets from diversified lenders building scaled gold loan franchises, including through employee poaching and superior technology, increases the risk of higher customer acquisition and retention costs and puts sustained pressure on net margins.
• Increasing regulatory scrutiny and evolving RBI frameworks around gold loan loan to value norms and product structures may cap the ability to drive higher ticket, higher yield products and may limit AUM growth and dampen earnings expansion over time.
• Greater strategic push into non gold segments such as microfinance, personal loans and vehicle finance, while intended to diversify, exposes the group to higher credit risk and cyclical stress, which can dilute consolidated return ratios and elevate credit costs, weighing on net profit.
• Growing dependence on external commercial borrowings and capital market funding at a time of shifting global interest rate cycles creates refinancing and currency related vulnerabilities that could raise funding costs and erode spread based earnings if conditions turn adverse.

Assumptions

This narrative explores a more pessimistic perspective on Muthoot Finance compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Muthoot Finance's revenue will grow by 11.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 49.4% today to 53.6% in 3 years time.
• The bearish analysts expect earnings to reach ₹111.4 billion (and earnings per share of ₹278.42) by about December 2028, up from ₹73.3 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹136.1 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 15.0x on those 2028 earnings, down from 21.0x today. This future PE is lower than the current PE for the IN Consumer Finance industry at 24.0x.
• The bearish analysts expect the number of shares outstanding to grow by 2.18% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.02%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Consolidated loan assets under management have already grown 42% year on year to INR 1,47,673 crores, and management has upgraded gold loan growth guidance to 30% to 35%. This indicates that strong structural demand for gold backed credit could sustain high single to double digit revenue growth rather than a decline in the medium term, supporting earnings.
• Standalone profit after tax has risen 88% year on year to INR 4,391 crores and consolidated profit is up 74% year on year, while yields are being maintained around 18.5% with a falling cost of funds. This suggests that net interest margins and overall profitability could remain resilient, limiting downside to earnings.
• Favorable regulatory developments for the gold loan sector, including RBI clarifications and new latitude on loan to value norms, combined with higher gold prices and tighter norms on unsecured credit, may structurally shift more borrowers into secured gold loans. This could bolster long term loan growth, revenue and asset quality driven earnings.
• Muthoot is deepening diversification with subsidiaries in housing finance, insurance broking, Sri Lankan lending and vehicle finance, while microfinance losses are narrowing and new gold loan branches are being opened. These developments could reduce concentration risk and create multiple profit pools that stabilize or increase consolidated earnings over time.
• Management continues to invest in branch expansion, digital transformation and customer acquisition, consistently adding roughly 4.2 lakh new customers each quarter and keeping auctions and stage III levels manageable. This points to a scalable franchise and improving operating leverage that may sustain or improve net margins and returns on equity.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Muthoot Finance is ₹2500.0, which represents up to two standard deviations below the consensus price target of ₹3501.89. This valuation is based on what can be assumed as the expectations of Muthoot Finance's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹4105.0, and the most bearish reporting a price target of just ₹2500.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ₹208.0 billion, earnings will come to ₹111.4 billion, and it would be trading on a PE ratio of 15.0x, assuming you use a discount rate of 16.0%.
  
• Given the current share price of ₹3837.6, the analyst price target of ₹2500.0 is 53.5% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.