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Pivoting towards a more diversified loan mix…

…however, outlook on the Gold loan business remains clouded

* MGFL reported a strong improvement in standalone margin and spreads. There was a QoQ improvement of ~240bp in Gold loan yields to 22.1% and an expansion of ~230bp in standalone spreads, aided by benign borrowing cost. Consolidated PAT grew 11% YoY and 45% QoQ to ~INR4.1b (17% beat).

* NII (6% beat) grew 9% YoY and 13% QoQ to INR10.8b. Operating expenses were elevated and rose 20% YoY. PPOP (11% beat) rose 5% YoY and 24% QoQ. Consolidated credit costs stood ~INR805m (PQ: INR1.3b) due to lower credit costs in the MFI business (in line with the management’s guidance).

* The important question at this juncture is whether the narrative for MGFL should now change from Gold loan growth and margin compression to healthier yields and diversification in the loan book. We feel MGFL should tread carefully in the non-Gold segments as it has yet to exhibit a clear ‘right to win’ in these segments and strong non-Gold AUM growth is also fraught with risks.

* The near-term trade-off between margin and Gold loan growth will continue as there is no let-up in the aggression among Banks, Gold loan FinTechs, and even other NBFCs who disburse Gold loans. The management said demand in the lower ticket Gold loans (which is core to Gold loan NBFCs) and the rural segment has exhibited early signs of an improvement.

* In the current environment, Gold loan growth for MGFL will be a casualty since the priority has shifted to spreads and margin. Reported Gold loan margin in 2QFY23 is near the peak, since there is no scope to increase yields further in the current competitive landscape, and borrowing costs will gradually rise, even if we factor in benefits from the maturity of higher-cost ECBs in Jan’23.

* We have raised our FY23/FY24 EPS estimate by 5%/9% to factor in higher margin in the Gold loan segment and moderation in credit costs in the MFI business. We estimate a 2%/12% AUM CAGR over FY22-24E in Gold/ consolidated AUM. We model a consolidated PAT CAGR of 13% over the same period for a consolidated RoA/RoE of ~4.1%/17% in FY24.

* These are at cyclical lows and muted Gold loan growth expectations are already reflected in the valuations at 0.9x FY24E P/BV. We maintain our Buy rating with a TP of INR140 (based on 1.1x FY24E consolidated BVPS).

Sharp decline in Gold AUM; High-yield model still keeping outlook clouded

* Gold AUM fell ~6% QoQ to ~INR192b. Gold tonnage fell by~6% QoQ to 63t. AUM mix suggests that teaser-rate Gold loans yielding sub-12%, which had touched a peak of 50% in Mar’22, has now fallen to 25% in Sep’22.

* The sequential decline in Gold AUM was driven by run-down of teaser rate loans and AUM loss in lower-yielding loans.

* LTV in Gold loans improved by ~100bp QoQ to 66%, while the average ticket size in gold loans fell to INR54.7k (PQ: INR56.3k).

Strong growth in the MFI business; largely the end of elevated credit costs

* MFI AUM was flat YoY, but grew by ~9% QoQ to INR71.2b. Annualized credit costs for Asirvad MFI fell to 3.1% (PQ: 6.8%) in 2QFY23. The management expects credit costs to moderate to pre-COVID levels.

* GS3 for Asirvad MFI increased by ~110bp QoQ to 8.8% (PQ: 7.7%), led by slippages from the MFI restructured pool.

Highlights from the management commentary

* Overseas borrowings are due for redemption in Jan'23. There is further headroom to increase short-term borrowings via commercial papers. The management expects borrowing costs to remain stable in the near-term.

* Increase in OPEX was on account of rising employee expenses, led by a) salary hike provided to entry-level employees; and b) addition of 1,500 employees in the Vehicle and MSME segments. Salary increases taken to retain employees. Attrition had risen to 8-9% per month during the COVID-led lockdown period, but has now declined to 5% per month.

Valuation and view

* While the management has highlighted that demand in small-ticket and rural Gold loans have recovered, we continue to monitor the sustainability of this demand at Gold loan yields of 21-22% offered by MGFL. The management has clearly articulated that it does not wish to pursue growth at the cost of a compression in spreads, which is a big positive for profitability.

* We believe the risk-reward for MGFL, at 0.9x FY24 P/BV, is still favorable for a consolidated RoA/RoE of 4.1%/17% over FY23-24. We maintain our Buy rating with a TP of INR140 (based on 1.1x FY24E consolidated BVPS).

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