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L&T Finance Holdings (LTFH)
Initiate N(V): Unique positioning
A diversified business model leveraged to long-term play on
rural economy and infrastructure development
Rates having peaked, the worst may be over for NIM, but asset
quality concerns remain given high unseasoned loan book
Returns to improve, but already priced in; initiate coverage
with Neutral (V) and TP of INR51
Long-term growth opportunity. LTFH is a unique non banking finance company (NBFC) with a diversified
asset model vs the traditional single asset class model. It focuses on two of the most underpenetrated segments
of the Indian economy – rural and infrastructure – which offer diversification in retail (34%), infrastructure
(40%) and corporate (25%), as well as a good long-term growth opportunity. It has a strong parent and an
experienced management team with intellectual and execution capability to deliver. On top of this, a potential
banking licence would be a significant long-term positive.
Medium-term concerns. While we believe the long-term outlook is promising, there are some concerns in
the medium term, most importantly related to the efficacy of its business model vs the traditional model. Its
quasi-banking strategy has received mixed reactions from investors, who generally prefer NBFCs for specific
asset segment expertise and banks for diversity. We believe investors were concerned about LTFH’s high
growth over the past two years, and lacklustre performance on margins and asset quality expected in FY12
could further dampen investor sentiment.
Returns are bottoming and should improve, but… ROA will decline significantly to 1.7% in FY12e from
2.5% in FY11, well below the average peer ROA of c3%. The expected sharp decline should be driven by
funding cost increase and high slippages from the microfinance (MFI) segment. With rates peaked out and
liabilities diversifying in FY13, we believe margins will bottom out in 4Q FY12 before improving, but will
not go back to FY11 levels until FY14. Asset quality remains a concern for us, given the nascency of most
asset segments, a high unseasoned loan book, and the fact that LTFH has yet to see a full NPL cycle.
Therefore, credit costs should remain high at the current levels. Overall, returns should improve – ROA to 2%
and ROE to 15% in FY14e, from 1.7% and 11% in FY12e, respectively – but should remain below peers’.
Initiate with Neutral (V). LTFH is trading at 12-month rolling forward PE of 13x and PB of 1.5x, a
respective 60% premium and 8% discount to peers. Our target is based on a blend of PE, PB and economic
profit model (EPM) methodologies. With EPS growth expected to normalise over the next few years, the PE
premium should decline. LTFH currently trades at a PEG ratio of 0.45x, which is not expected to re-rate
materially, as the earnings outlook is uncertain. This implies a 12-month forward target PE of 11x. For the PBbased
valuation, we use a Gordon growth model to arrive at a 12-month forward target PB of 1.5x. Blending
these with our EPM-based valuation of INR48, we arrive at a TP of INR51, implying a 7% potential return.
Key upside risks: (1) sharp decline in rates, (2) potential banking licence, and (3) asset quality risks not
materialising. Key downside risks: (1) rates remaining high and (2) asset quality risks increasing.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
L&T Finance Holdings (LTFH)
Initiate N(V): Unique positioning
A diversified business model leveraged to long-term play on
rural economy and infrastructure development
Rates having peaked, the worst may be over for NIM, but asset
quality concerns remain given high unseasoned loan book
Returns to improve, but already priced in; initiate coverage
with Neutral (V) and TP of INR51
Long-term growth opportunity. LTFH is a unique non banking finance company (NBFC) with a diversified
asset model vs the traditional single asset class model. It focuses on two of the most underpenetrated segments
of the Indian economy – rural and infrastructure – which offer diversification in retail (34%), infrastructure
(40%) and corporate (25%), as well as a good long-term growth opportunity. It has a strong parent and an
experienced management team with intellectual and execution capability to deliver. On top of this, a potential
banking licence would be a significant long-term positive.
Medium-term concerns. While we believe the long-term outlook is promising, there are some concerns in
the medium term, most importantly related to the efficacy of its business model vs the traditional model. Its
quasi-banking strategy has received mixed reactions from investors, who generally prefer NBFCs for specific
asset segment expertise and banks for diversity. We believe investors were concerned about LTFH’s high
growth over the past two years, and lacklustre performance on margins and asset quality expected in FY12
could further dampen investor sentiment.
Returns are bottoming and should improve, but… ROA will decline significantly to 1.7% in FY12e from
2.5% in FY11, well below the average peer ROA of c3%. The expected sharp decline should be driven by
funding cost increase and high slippages from the microfinance (MFI) segment. With rates peaked out and
liabilities diversifying in FY13, we believe margins will bottom out in 4Q FY12 before improving, but will
not go back to FY11 levels until FY14. Asset quality remains a concern for us, given the nascency of most
asset segments, a high unseasoned loan book, and the fact that LTFH has yet to see a full NPL cycle.
Therefore, credit costs should remain high at the current levels. Overall, returns should improve – ROA to 2%
and ROE to 15% in FY14e, from 1.7% and 11% in FY12e, respectively – but should remain below peers’.
Initiate with Neutral (V). LTFH is trading at 12-month rolling forward PE of 13x and PB of 1.5x, a
respective 60% premium and 8% discount to peers. Our target is based on a blend of PE, PB and economic
profit model (EPM) methodologies. With EPS growth expected to normalise over the next few years, the PE
premium should decline. LTFH currently trades at a PEG ratio of 0.45x, which is not expected to re-rate
materially, as the earnings outlook is uncertain. This implies a 12-month forward target PE of 11x. For the PBbased
valuation, we use a Gordon growth model to arrive at a 12-month forward target PB of 1.5x. Blending
these with our EPM-based valuation of INR48, we arrive at a TP of INR51, implying a 7% potential return.
Key upside risks: (1) sharp decline in rates, (2) potential banking licence, and (3) asset quality risks not
materialising. Key downside risks: (1) rates remaining high and (2) asset quality risks increasing.
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