Improving Asset Quality And Lower Credit Costs Are Expected To Drive Stronger Long-Term Returns

Catalysts

About Muthoot Microfin

Muthoot Microfin is a microfinance institution focused on providing income generating loans and complementary secured products to underserved rural and semi-urban borrowers across India.

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

• Steady improvement in asset quality, with GNPAs and credit cost trending down and supported by stronger in-house scorecards and tighter underwriting, can release provisions and structurally lift earnings and net margins.
• Scaling of higher ticket Individual Loans, Micro LAP and Gold-linked products to existing high-score customers deepens wallet share without commensurate branch expansion. This may accelerate revenue growth while reducing cost to income.
• Normalization of customer cash flows and improving collection efficiency in a healthier macro environment, including better rural cash generation, supports AUM growth and lower credit costs, which can enhance ROA and ROE.
• Continued reduction in cost of funds through diversified bank relationships, structured PTCs and ECB access, together with an upgraded rating outlook, can widen net interest margins and strengthen profitability.
• Branch and staff rationalization, combined with digital collections for newer products, is likely to drive operating leverage as disbursements grow. This can improve operating expenses as a percentage of assets and support higher earnings.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Muthoot Microfin's revenue will grow by 87.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from -82.1% today to 29.2% in 3 years time.
• Analysts expect earnings to reach ₹8.4 billion (and earnings per share of ₹31.28) by about December 2028, up from ₹-3.6 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as ₹6.9 billion.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 7.1x on those 2028 earnings, up from -8.3x today. This future PE is lower than the current PE for the IN Diversified Financial industry at 22.0x.
• Analysts expect the number of shares outstanding to decline by 2.91% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 21.61%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Credit quality improvements may prove cyclical rather than structural, with Stage 2 assets of around INR 350 crores and fresh flows of roughly INR 110 crores into NPAs each quarter indicating that any macro slowdown or weather shock in rural India could quickly reverse the current decline in GNPAs and credit cost, pressuring earnings and net margins.
• The strategy of concentrating growth into higher ticket Individual Loans and Micro LAP for 700 plus score customers, alongside rising average ticket sizes across the industry, increases borrower leverage and exposure to income volatility at the bottom of the pyramid, which could curb disbursement growth and drive up delinquencies, negatively impacting revenue and net margins.
• Branch rationalization and employee exits aimed at saving around INR 50 crores annually, combined with rapid product diversification into Individual Loans, LAP and Gold Loans without commensurate field build out, may weaken on ground monitoring and collections over time, leading to higher slippages and elevated credit cost that would dilute earnings.
• The current funding tailwinds from supportive banks, large PTC transactions and falling average cost of funds from 11.02% to 10.6% depend on a benign liquidity and regulatory environment for microfinance, and any tightening in risk appetite, rating setback or sector specific event risk could drive funding costs higher or constrain growth, compressing net interest margins and earnings.
• Management’s guidance of exiting near 2% ROA and lowering steady state credit cost to around 2.25% to 2.5% by FY 27 assumes sustained high disbursement growth of around 28% and stable rural demand. However, prolonged high cost to income ratios near 60% or slower AUM growth than the targeted 10% plus could prevent operating leverage from materializing, limiting improvement in ROA, ROE and overall profitability.

Valuation

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

• The analysts have a consensus price target of ₹215.0 for Muthoot Microfin based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹240.0, and the most bearish reporting a price target of just ₹190.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be ₹28.8 billion, earnings will come to ₹8.4 billion, and it would be trading on a PE ratio of 7.1x, assuming you use a discount rate of 21.6%.
  
• Given the current share price of ₹177.93, the analyst price target of ₹215.0 is 17.2% higher.
  
• 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.