Muthoot Finance Non Convertible Debenture
Largest gold loans company in India, Muthoot Finance (Muthoot), is here to offer non-convertible debentures to retail investors. Here is our take on it:
Issuer: Muthoot Finance
Listed securities: Equity shares on Bombay Stock Exchange (BSE) National Stock Exchange (NSE)
About the business:
Muthoot is a force to reckon with when it comes to personal loans and business loans given against collateral of bullion gold, gold jewelery and any other form of gold. 99% of the asset portfolio (read loans given) by the company are loans against gold. On an average company has lent 72% of the value of gold, maintaining good margin of safety. Non Performing assets of this company stand at 0.33% as on March 31, 2011. That makes it an attractive bet.
The company mainly operates in South India and has been expanding in rest of India. The company tapped equity markets to raise additional funds and then there was a private placement of debentures. In the past, the company has been raising money from private placement of non-convertible debentures.
The financial health of the company is good. Capital adequacy ratio stands above stipulated 15. Credit rating agency CRISIL has rated this non-convertible debentures as AA- (AA minus). This 'investment grade rating' indicates that there is low credit default risk. The rating captures company's experience of 70 years in gold financing business. But the 'Minus' sign connotes that this is one of the lower quality paper in AA segment. ICRA has maintained similar view on credit rating for this NCD issuance of the company. A point to note that these credit rating are subject to periodic review and may change from time to time.
Returns
Company is offering 12% returns on two year NCD. It is a very good return, if we compare what an AA rated bond offers for two year maturity. The return on Muthoot two year NCD are at least 200 basis points higher than a AA rated paper with two year residual maturity. That makes this NCD an interesting bet.
But what about three and five year NCD. Many do not like these papers. They reason that these two NCD offer only 20 basis points more or 12.2% returns which is not attractive. One should look into these returns in light of where rates are expected to move. Bank fixed deposits will offer a better cue here. Go to any bank and ask for bank fixed deposit rates for one year and five year deposits. One year fixed deposits are offering at least 100 basis points more than the five year fixed deposits. Bankers are expecting rates to fall over next couple of years.
So what is our call on this?
We are not really enthused with 12% returns. It is a good enough reward not a great reward. As equity markets tank, many prefer to rush for bonds in 'risk off' mode. But we are of the opinion that equities offer better risk-adjusted returns than bonds. We have look at NCD from different angle.
If you are really keen, go for a five year NCD. If the rates fall in natural course of action over next couple of years, you still get to enjoy high coupon of 12.2% payable annually till maturity. But what if, there is a 'sudden' recession worldwide? Something that happened in calendar year 2008, if repeats now, and rates are cut over next couple of quarters, five year NCD may offer good capital appreciation over next 18 months itself. Take the risk, if you can stomach.
But what are the risks?
We have seen that with two year NCD will expose you to reinvestment risk, as rates are expected to fall. There are couple of more issues we cannot ignore
This is a gold financing business. It means everything depends on gold or rather gold prices. Gold prices have been showing good momentum upwards. The demand for safe haven, may keep pushing the prices up, making business viable and increasing margin of safety. But what will happen if gold prices show massive reversal in short term. In that case, company runs big risk of defaults and non performing assets taking the business down.
Company though has done very well in past, the business has been experiencing entry of new players – organised ones – banks, who have access to cheaper funds and can lend at a lower rates. If Muthoot cannot bring down the cost of funds and at the same time banks increase their offering in gold financing business at a lower rate, Muthoot will find it difficult. This risk may not materialise in short term, but a five year investor must give a serious thought to this risk.
Five year investors should ideally be in a liquid instrument. Listing on BSE and NSE does not help, if the instrument is thinly traded. Liquidity is a must if you are looking for capital appreciation or for an emergency exit. Unfortunately it is not guaranteed.
Issue details:
Issue opens: 23 August 2011
Issue closes: 5 September 2011
Minimum Investment: Rs 5000 (Minimum five NCD)
Issue Size: Rs 500 crore with an option to retain over subscription of Rs 500 crore
Allotment: First comes first served basis.
To sum up, if you are keen to invest, nothing stops you.
Disclosure: We have advised our clients to let go this issue of NCD.
