Name	Reco Date	Reco price	Target	Prospero Rating	Report Date*
Muthoot Capital	03Jun2014	Rs. 126	Rs. 280	6 / 10	03Jun2014

A) Company background: Muthoot Capital Services (MCS) is a BSE listed company and belongs to the Muthoot Pappachan Group (blue colored Muthoot logo). Muthoot Capital operated in the 2 wheeler lending space and has a loan book of around Rs. 641 crores.
The Muthoot Pappachan group owns another company named Muthoot Fincorp Limited (unlisted) having a total lending book of more than Rs. 15,000 crores. The group is a very well-known group with interests in finance, hospitality, infrastructure and automobile industry.

B) Investments arguments:

Catering to 2-Wheeler financing requirement where competition is lower
Muthoot Capital Services (MCS) is engaged in financing 2 wheelers mainly for Hero bikes and Honda bikes. As on March’14, loan book stands at Rs. 641 crores, of which 96% is constituted by 2 wheelers. MCS has successfully scaled up its operation at the time when most other players have burnt their hands and are slowly down sizing operations. Competitors like Fullerton, CitiFinancial and GE Money have been scaling down operations leaving only a handful of players like HDFC Bank, IndusInd Bank, Bajaj Finance and Shriram City Union. MCS has a 25% market share in Kerala. however. its total market share is just 2% in the Indian 2 wheeler financing market. MCS has presence in 7 states through a network of 1,200 dealers and aims to reach to a 12-15% market share in coming years.

Operating leverage to kick in
MCS uses the entire branch network of Muthoot Fincorp and that enables itself to grow very rapidly. Muthoot Fincorp has an excellent penetration with 3,000 branches and that helps the company to easily source business. The management expects to have a loan growth of 30% CAGR in next 3 years. For the same reason, the company has been heavily spending on the recruitment and improvement of technology. However, going forward, the cost will not increase in the same range as its income and will give a significant boost to its profitability.

Strong asset quality
On an average, credit losses in the 2 wheeler financing are high at 2-4% for the industry. MCS has historically managed with less than 1% losses on account of its robust appraisal and recovery practices. The entire process for loans is handled by its employees rather than a DSA. For recovery, MCS has a team of 800 employees who religiously follow-up with potential defaulting customers. This has helped the company to retain its healthy asset quality.

High growth, attractive valuations
MCS offers its flexible financing schemes to rural population (unsalaried & self-employed) and with its relatively lower market share, is poised to grow at a very healthy rate of 30% CAGR. MCS has laid a very strong foundation by expanding its employee strength for business origination as well as in recovery & risk management. It has also heavily invested in improving the systems and automating the same. This will surely bring in operating leverage benefits and will ensure an even higher profit growth over next few years. This high growth will easily drive the ROE levels to 22%-25% range. At our recommendation price of Rs 120-125, MCS trades at less than its FY16 book value.

We believe there is a huge potential for re-rating in MCS as its growth story unfolds.

C) Key risks: Inability to manage the NPAs

• On the behavioral side: We hear a lot of private equity deals in this space. If this company is able to grow at such high speed of 30% CAGR, there will be HUGE institutional demand for MCS when the next fund raising exercise will be done. The risks to the story are few and the rewards are extremely higher.
   
• Some grapevine: A couple of private equity players had in the past approached the company for equity dilution, however, the promoter of MCS was not ready to dilute the company at that price and is looking for a significantly higher premium. We estimate that the equity dilution exercise will only come once the company demonstrates a phenomenal growth in income as well as profits.

*Report Date may sometimes be different from Recommended Date.

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