L&T FINANCE HOLDINGS: LTFH is a unique non banking finance company (NBFC) with a diversified asset model

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.
RISH TRADER