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Trading off margin and spreads for Gold loan growth

* MGFL reported a consolidated PAT (11% miss) of INR3.7b, down 9% YoY and 15% QoQ. NII declined by 4% QoQ to INR9.9b (in line), driven by a compression in spreads.

* PPOP (7% miss) declined by 8% YoY and 15% QoQ to INR6b.

* Credit costs remained elevated in the MFI subsidiary due to the impact of the second COVID wave. We expect credit costs to remain elevated in 3Q and moderate from 4QFY22 onwards.

* While MGFL demonstrated greater sequential Gold loan growth (~13% QoQ) by effectively winning over higher ticket Gold loan customers, this has come at the cost of compression in spreads and large incentives paid to employees. MGFL has embarked on a change in its business model and has traded-off spreads/margin for Gold loan growth. There will be a structural compression in spread/margin in the subsequent quarters, but MGFL is betting on mitigants like improvement in its cost ratios and leverage, driven by a strong growth in AUM.

* As a franchise, MGFL has made considerable progress in its appraisal, security infrastructure, and other processes over the last three years. It can deliver a healthy consolidated AUM CAGR of ~17% over FY21-24E. We estimate a consolidated RoA/RoE of 5.9%/22% over the medium term and maintain our BUY rating with a TP of INR230/share (1.7x Sep'23E BVPS).

Healthy sequential growth in Gold loans and MFI

* Gold AUM rose 13% QoQ, but fell 5% YoY to INR187.2b. Gold tonnage grew 11% QoQ, but fell 6% YoY to 64.7t.

* Within Gold loans, LTV increased by 200bp QoQ to 67%, while average ticket size (ATS) rose to INR48.1k (v/s INR46.5k YoY and INR42.7K QoQ), driven by the healthy acquisition of higher ticket Gold loan customers.

* MFI AUM was up 18% QoQ and 44% YoY, driven by healthy disbursements in 2QFY22. We expect growth in MFI to moderate in 2HFY22.

* Consolidated AUM rose 15% QoQ and 6% YoY to INR284.2b. The share of non-Gold businesses increased by 100bp QoQ to 34%.

Credit costs remain elevated in the MFI segment; minor improvement in standalone asset quality

* Asirvad MFI seems to have taken higher write-offs in 2QFY22, which led to credit costs of 5.8% (v/s 6% in 1QFY22).

* GNPA declined by 100bp QoQ to 2.6% in MFI. However, PAR0+ in the MFI segment increased for the second consecutive quarter by ~340bp to 25.8% in 2QFY22 from its previous peak of ~21% in Sep’20.

* Standalone (Gold + Vehicle) GNPA/NNPA improved by 40bp/30bp QoQ to 1.6%/1.3%.

* Consolidated credit costs stood ~1.6% (v/s 1.9% in 1QFY22) and continued to remain elevated, driven majorly by the MFI business.

Compression in spreads and margin driven by a moderation in yields

* Consolidated spreads (calculated) declined by 140bp YoY and 80bp QoQ, driven by a sharp decline in consolidated yields to 22.8% (down 130bp QoQ). Moderation in yields was mitigated partially by a decline of ~50bp QoQ in consolidated CoB. Consolidated NIM fell 90bp QoQ to 15.2%.

Elevated cost ratios

* Operating expenses (18% miss) rose 30% YoY and 23% QoQ, with the CIR increasing 8pp YoY and 9pp QoQ to ~43%. This was driven by onboarding of ~1,620 employees in sales/marketing functions, higher incentives being paid to employees (based on higher Gold loan volumes), and higher advertising/publicity expenses.

Other details

* Borrowing mix changed, with the proportion of bank loans increasing by 11pp QoQ to 43%. MGFL seems to have effectively leveraged its short-term bank term loans for incremental borrowings in 2QFY22.

Highlights from the management commentary

* Restructuring was largely in the MFI business (~INR10b). Asirvad is carrying 18% PCR on INR7.3b of its restructured MFI book.

* The management expects yields to settle ~200bp lower than 2QFY22 levels. The one-quarter of yield decline will be mitigated by a reduction in the cost of funds. It expects a 150bp net impact on spreads.

* MGFL does not expect a material increase in operating expenses. With a strong growth in AUM, it expects cost ratios to trend lower.

Valuation and view

* MGFL has traded off spreads/margin to demonstrate high sequential growth in Gold loans in 2QFY22. The company is transforming its business model, and it will be important to understand the contours of this transformation to decipher its medium-term trajectory, as there will be a glide-path of six months. At the end of this period, we expect a more sustainable medium-term RoA/RoE profile to emerge.

* MGFL had witnessed volatility in its Gold AUM over the past few quarters. We expect it to address some of these challenges under its new business model. The proportion of MFI business has now reached 25% of consolidated AUM. We would continue to monitor signs for any further stresses in the MFI book and expect credit costs in the segment to remain elevated in the near-term. We have cut our FY22E/FY23E estimate by 16%/11% to factor in lower NII and higher operating expenses. We model consolidated AUM and PAT CAGR of ~17% and ~14% respectively over FY21-FY24E.

* MGFL trades at 1.6x FY23E P/BV. The risk-to-reward is favorable, considering that it can still deliver consolidated RoE of ~22% over FY23-24E, even under the new business model. We maintain our Buy rating, with TP of INR230/share (1.7x Sep’23E BVPS).

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