Is Manappuram Finance poised for a re-rating?

Gold has long been a symbol of security and investment in India. Its latest rally - driven by global economic uncertainty, inflation, and central bank buying - has brought cheer to households and investors alike. But one industry benefits even more directly from soaring gold prices: gold loan financiers.

Higher gold prices translate into larger loan amounts per gram, better loan-to-value (LTV) ratios, and lower default risks. These tailwinds have historically favoured Muthoot Finance and Manappuram Finance , two dominant players in India's gold loan sector. Yet, despite their comparable profitability and growth metrics, Manappuram Finance trades at a steep discount to Muthoot Finance.

The latest buzz in the market suggests Bain Capital (a private equity firm) is nearing a deal to acquire a significant stake in Manappuram Finance. First reported in November 2024, the news has fuelled speculation over a long-awaited rerating. But before investors assume that a private equity infusion is the silver bullet, a closer look at the underlying business realities is warranted.

Same metal, different shine: The Muthoot-Manappuram valuation gap

The most glaring anomaly between the two lenders is their market valuation. While Muthoot Finance consistently commands a premium price-to-book (P/B) multiple, Manappuram Finance languishes at a discount. At first glance, this discrepancy appears puzzling. Both companies have delivered steady asset under management (AUM) growth, maintain similar ROEs and operate in the same industry with the same tailwinds.

Yet, markets rarely price businesses on financials alone. Business model efficiency, management credibility, regulatory risks, and long-term competitive positioning all play a role in valuation. And here, Manappuram has structural disadvantages that extend beyond investor perception.

Suggested read: A high ROE may not mean what you think | Understanding the P/B Ratio

Business model matters: Loan tenure & cost efficiency

Gold loan businesses thrive on cost efficiency and customer retention. Muthoot Finance has mastered both.

It offers 12-month loan tenures, ensuring:

• Lower churn : Borrowers stay in the system longer.
  
• Operational efficiency : Fewer loan renewals mean lower processing costs.
  
• Better customer loyalty : Less risk of defaults and auction sales souring relationships.

By contrast, Manappuram Finance operates on a 3-month loan tenure, leading to:

• Frequent churn : Borrowers exit and re-enter multiple times a year.
  
• Higher operational costs : Loan renewals are more frequent, adding administrative burden.
  
• Customer attrition : Frequent auctions, though useful for controlling NPAs, could deter repeat borrowers.

In an industry where cost efficiency dictates margins, Manappuram Finance's model appears structurally less scalable than Muthoot Finance's. Even if Bain Capital steps in, this operational disadvantage will not disappear overnight.

Brand stickiness and trust factor

Beyond operational efficiencies, Muthoot Finance enjoys a brand advantage that is difficult to replicate.

• With a 135-year legacy, Muthoot Finance has built deep-rooted trust among borrowers, particularly in rural and semi-urban areas where gold loans are a preferred financing option.
  
• Gold loan customers often rely on lenders they trust, as the transaction involves pledging family assets. The perception of stability and ethical lending practices plays a crucial role in borrower retention.
  
• Even if interest rates are marginally higher, customers prefer a lender they know will safeguard their gold, rather than opt for a new, less familiar lender.

Manappuram Finance, despite its scale, does not command the same level of customer loyalty. Frequent gold auctions - while necessary to control defaults - could discourage borrowers from returning. This lack of brand stickiness limits pricing power and loan growth.

For Manappuram Finance to close the valuation gap, it would need more than just operational fixes - it requires a shift in customer perception, something that cannot be achieved quickly.

Regulatory and competitive risks: The double squeeze

Beyond business model inefficiencies, Manappuram Finance faces two pressing risks - rising bank competition and regulatory scrutiny over its microfinance arm.

Banks are eating into gold loan NBFCs' market share

The days of NBFCs enjoying a virtual monopoly on gold loans are fading. Indian banks, flush with liquidity and access to cheaper capital, are aggressively expanding into the segment.

• Gold loans issued by banks have risen 37 per cent per annum during 2020-24, undercutting NBFCs on interest rates.
  
• Unlike NBFCs, banks are not constrained by high borrowing costs, allowing them to offer lower rates.

For borrowers, this means a straightforward decision: Why borrow from an NBFC when a bank offers the same loan at a cheaper rate?

Problems in the microfinance biz

Manappuram's biggest valuation drag is its rising exposure to microfinance - a sector inherently riskier than gold lending.

• The company's microfinance subsidiary, Asirvad Microfinance, now accounts for 28 per cent of its total AUM (as of FY24), up from just 3 per cent in FY15.
  
• In contrast, Muthoot has limited its microfinance exposure to 11 per cent, reducing risk concentration.
  
• The RBI recently imposed lending restrictions on Asirvad, citing excessive interest rates. Though these have been lifted, the episode reinforces governance concerns.

The role of management and culture

Corporate governance and leadership are critical drivers of valuation, yet Manappuram Finance has struggled in this area. The Enforcement Directorate (ED) probe into the promoter in 2023 and the RBI's initial resistance to appointing his daughter to the board raised concerns about succession planning.

While governance concerns have not derailed operations, they weigh on investor confidence. Markets tend to reward companies with professional leadership and clear succession planning, factors that Muthoot Finance has managed better than Manappuram Finance.

Will Bain Capital drive change or just provide capital?

Bain Capital's potential investment has raised expectations of a turnaround story, but its impact depends entirely on execution.

A private equity firm's primary goal is to deliver high returns within a 5-7 year timeframe, not to build a business for the next three decades. If Bain remains a passive investor, providing only capital, little will change in Manappuram's underlying business.

For meaningful value creation, Bain would need to:

• Push for longer loan tenures to reduce customer churn.
  
• Improve branch productivity and operational efficiency.
  
• Enforce stronger capital allocation discipline to de-risk from microfinance.

Its track record in India offers mixed signals. Bain's minority stake in Axis Bank and L&T Finance did not lead to a drastic valuation rerating. But in 360 ONE (formerly IIFL Wealth), where Bain had strategic control, operational performance improved significantly.

Final word

Manappuram Finance is at a crossroads. The potential entry of Bain Capital could be a positive catalyst, but only if it leads to:

• Operational restructuring to improve cost efficiency
  
• Stronger governance and regulatory compliance
  
• A clear de-risking strategy for microfinance

For now, the valuation gap with Muthoot Finance is not just a market anomaly - it reflects structural weaknesses in business execution and governance.

Investors betting on an automatic rerating should wait for clarity on Bain's actual role. Because in investing, as in gold lending, terms matter more than promises.

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Also read: Manappuram Finance's valuation is at historic lows. Is it a value buy or trap?

This article was originally published on March 01, 2025.