LIC Housing Finance (downgrade to reduce): Edelweiss

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LIC Housing Finance (LICHF IN, INR 1,058, downgrade to reduce)

We believe the CBI investigation on corporate loan cases of LIC Housing Finance (LICHF) will have negative implications on the company, both from financial as well as sentimental perspective.  In the past 2 years, the stock has re-rated from <1x book to as high as ~3x on the back of consistently improving operating metrics under the regime of Mr. R.R. Nair. Its RoEs improved from 15-18% in FY05-07 to 23-25% in FY10-FY11, as disbursements grew from single digits in FY06-07 to 70% in FY10 (37% in H1FY11) and gross NPLs came off from 4.4% in FY05 to <1% in FY10.

n  Conservative approach towards developer segment to impact earnings growth

CBI has registered a case of corruption against Mr. R.R. Nair, director and CEO, LICHF, and arrested him. In the interim, with the change in management (Mr. V.K. Sharma - zonal manager of LIC, south zone appointed as the new CEO, w.e.f. November 25) and CBI investigation underway, we believe there will clearly be a shift in strategy from growth to a more cautious approach.

·         CBI investigation will jeopardize overall growth due to slow down in lending to corporate developer segment. We were building in 34% growth in loan book over FY10-12E, considering disbursement growth of 32%. While we expect traction in growth in individual loan segment to continue at 25%, conservative approach in disbursing developer loans results in disbursement estimate being revised downwards to 21% CAGR (refer table 2).

·         Lower proportion of high yielding corporate loans in incremental disbursements will impact margins as well (change in proportion of corporate loans from 12% to 9% will have 20bps impacts on margins). This is worrisome, as interest spreads in the individual loan segment are already under pressure due to competitive schemes being offered.

n  Outlook and valuations: Headwinds galore; downgrade to ‘REDUCE’

We are revising our EPS estimates downward by 6% to INR 94.2 in FY11 and 17% to INR 101.4 in FY12, factoring in lower disbursement growth, compression in margins (to 2.5%) and higher provisioning. RoEs, consequently, would come off to ~21% in FY12 from our earlier estimate of ~25%. Following the news of CBI investigation, LICHF’s stock price has corrected 20% in the past two days and is currently trading at ~2x book (against average of 1.5x during FY08-10 and 0.8x in FY02-07). Apart from financial impact, we believe the investigation will strain valuation multiples as well. We believe overhang of investigation, conservative growth strategy and lower RoE trajectory would lead to contraction in valuation multiple to 1.5x in the near term and we, therefore, downgrade our rating on the stock to ‘REDUCE/Sector Underperformer’ (from Buy).