Muthoot Finance’s (Muthoot) Q2FY18 PAT of INR4.5bn surpassed our and Street’s estimates, on optically higher revenue traction. Portfolio with 6-12 months’ maturity, falling due in Q2FY18, constituted 27% of overall loan book. This, when recovered post the due date, earns higher yields and commensurate penal interest. Given that further 11% of portfolio will fall overdue in Q3FY18, similar recovery momentum could crystalise into better revenue then as well. Hence, we revise up FY18E EPS >8%, but keep FY19E EPS broadly same. Meanwhile, AUM growth was muted (flat QoQ), largely on lower demand (GST impact on business segment) and higher auctions (INR7.7bn). GNPLs jumped to 4.6% (2.25% in Q1FY18), with >60% of incremental dues being driven by 6 months’ products. However, lower LTV and stable gold price lend comfort on recoverability. Non-gold businesses, which currently contribute ~7% to earnings, to scale up to 9-10% by FY18. Given revenue tailwinds and controlled opex, we estimate Muthoot to post >18% earnings CAGR over FY17-19. Maintain ‘BUY’ with TP of INR570.

Overdue recovery leads to strong revenue momentum

Muthoot reported optically higher revenue growth, even while AUMs were flattish. The rise was largely to do with recovery in overdue portfolio maturing in Q2FY18, which attracted higher yield. This was further supported by continued funding cost benefits (6th quarter of decline). Meanwhile, given shorter duration loans (6 months) and transient pressure (demonetisation/GST challenges), GNPLs technically rose to INR12.6bn (INR6bn in Q1FY18), though likely to be recovered in ensuing quarters. This, along with upped standard asset provisions (1.25% vs. 1.0% earlier), led to higher provisions.

Modest AUM growth

Given structurally lower demand for short-term financing, Muthoot’s growth continued to be modest—at INR275bn, gold AUMs were flat—partly also impacted by continued auctions (INR7.7bn). Encouragingly, there is no let up in customer rollovers/additions, which indicates traction will improve as demonetisation /GST challenges wane.

Outlook and valuations: Growth to drive rerating; maintain ‘BUY’

Notwithstanding soft H1FY18, we expect AUM growth to pick up pace—with enhanced demand from business segment post stabilisation from GST phase. This, with controlled costs and provisioning, is estimated to drive >18% earnings CAGR. The stock is trading at 2.2x FY19E P/ABV for RoA/RoE of >5%/20%. We maintain ‘BUY/SO’.