Monday, September 17, 2012

Muthoot Finance NCD Opens - Should You Invest?

India’s largest gold loan company, Muthoot Finance Ltd, opened its latest Non Convertible Debenture Issue on Monday, September 17th.

This is the fourth time that this listed gold loan player headquartered in Kerala is tapping the NCD market for investments.

Though their first two NCDs happened when the gold loan business was ruling the NBFC sector as its most lucrative segment, the third had happened after RBI trained its regulatory guns on gold loan companies as well as its facilitators like public sector banks.

Due to this development, while the first two NCDs were runaway successes, the third could only be a reasonable success.

The fourth, however, comes when the dust has settled in the gold loan sector, and most frontline players like Muthoot Finance are once again executing plans to forge ahead under the new regulatory changes.

Non Convertible Debentures, like their name implies, are non convertible into equity or equity like instruments, which means it is really a form of pure debt from the company’s side, and a fixed-income instrument from the investors’ side.

However, NCDs will be listed in the exchanges, and could be traded in the secondary market like other listed debt instruments. But it is unreasonable to expect continuous high trading volumes like in stocks, with transactions happening more when yields become attractive or unattractive due to sudden changes like an interest rate change.

Maybe due to the uncertainties prevailing regarding the future of the high interest regime, Muthoot Finance has, this time, done elaborate homework to ensure that different kinds of investing needs are met.

There will be five options or schemes to choose from ranging from the lowest tenure of 24 months with the lowest annual interest of 11.50%, to the highest tenure of 72 months with the highest annual yield of 12.25%.

The latter scheme will double your investment within 72 months or six years, which will come across as attractive for long-term investors in fixed-income instruments.

In between these two extreme schemes, are three other options, one with a tenure of 36 months and annual yield of 11.75%, and two options with tenure of 60 months each, with they differing slightly in yield and frequency of interest payout. If the interest is paid out monthly the yield is 11.75%, and if it is received yearly, the yield is slightly higher at 12%.

Investors go in for NCDs vis-à-vis bank FDs for the benefit of higher interest rates for the same kind of tenures.

This attraction is all the more evident now, as Muthoot Finance’s NCD comes at a time when most observers feel that Indian interest rates have peaked out and is set to move down, which means that banks are likely to trim fixed-deposit rates, going forward.

If the inflation situation improves significantly due to the newly kick-started fiscal policies under Chidambaram as well as RBI’s continued diligence on the monetary front, it can lead to sharper rate cuts than normally expected by the market.

Even if it takes a couple of more quarters than expected, no one expects the nation to refrain from a rebound for the next two years, which is the minimum tenure of the Muthoot NCD.

If the investment opportunity offered is that attractive, investors new to NCDs may ask what is the catch, and the catch is, of course, that no NCDs are as safe as bank FDs.

Some NCDs have defaulted in India, with the most recent example being of the listed media giant, Deccan Chronicle Holdings.

However, here also, Muthoot Finance seems to have tried their best in making their NCDs secure compared with some peer group offerings. Technically, this NCD is senior and secured debt.

The term senior implies that in case of a catastrophe like winding-up, this debt will have high priority of repayment compared with other forms of debt like subordinate NCDs.

Secured debt implies that the company has set aside enough assets, in order to repay NCD holders, in case the company’s plans go awry and the their business doesn’t generate enough returns for normal repayment to NCD holders.

In contrast, some peer group NCDs which are open now, like IIFL’s NCD, is both subordinated and unsecured. But on the flipside, such NCDs offer higher yields, even up to 13.52%, due to their relatively riskier nature.

Apart from such technical aspects, one point NCD investors should be keenly looking at is the dynamics of the underlying business in which they are investing into, as well as the management quality.

Muthoot Finance will come across as reasonably powerful on both fronts. Though gold loan business is now a pale shadow of its former self with regard to its strong growth potential, there is no doubt that the new regulations by RBI has made the business more secure for the companies as well as its investors.

Secondly, even under the new stricter regime for gold loan companies, the increasing price of gold has ensured that companies like Muthoot are enabled to lend more for the same amount of gold, than was the situation two years back.

Muthoot’s management track-record is also reasonably powerful, as despite having strong competitors from Kerala itself in both the listed and unlisted space, Muthoot Finance still leads the sector with a clear margin, which is attributed partly to their centuries old business continuity.

The biggest risk for Muthoot Finance will be something that may affect all gold loan companies, which is a theoretical double whammy of gold prices crashing steeply, and at the same time, governments tightening their norms still further, like they did in the microfinance sector. However, it remains a theoretical risk as of now.

Muthoot Finance’s NCD closes on October 5th, and is targeting a collection of Rs. 250 crore, with an additional option to retain another Rs. 250 crore if the demand is strong.

Face Value of this NCD is Rs. 1000. The minimum application should be for ten NCDs (i.e. for Rs. 10,000) and in multiples of 1 NCD thereafter. Rating by CRISL and ICRA is AA-.

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