L&T Finance Holdings Research Report By IndiaNivesh

L&T Finance Holdings (LTFH) has moved up by 23% in last 3 months due to better than expected Q1FY17 performance, long term strategy of improving ROEs significantly from current 13% and significant valuation discount compared to peers. Recently we had an interaction with management of LTFH to know the developments with regards to implementation of new strategy. Thereafter we have revisited our estimates and assumptions to capture in slightly longer view in our model and its likely impact on valuations. We note that LTFH’s management has taken right steps to improve its long term ROEs materially from current 13% which will be led by 1) decline in defocused portfolio where the risk is higher like Infra, CV, CE and long term SME financing 2) significantly improving cost to income by closing the overlapped branches (like closing down a branch where there is a branch of L&T Finance and also of L&T Housing in same location / area), 3) reducing the risk in wholesale / infra business by focusing on only operational projects which is likely to limit provisioning and 4) stable consolidated NIMs. While there is upside risk to our margins assumption mainly due to 1) likely positive surprise from higher growth in Tractor book which is high yielding and 2) increase in Loan Against property and develop financing book which again is high yielding. Hence we upgrade rating to BUY with upwards revised target price of Rs 115, implying 2.8x FY18 ABV (3 years PT of Rs 155 based on 2.8x FY20 ABV). Timely implementation of strategy remains the key risk to our recommendation. (Please note that LTFH has changed its reporting methodology as a part of change in business strategy which is articulated in Q4FY16. Hence various break ups are provided in the form of 1) focused products and de focused products and 2) segmental break up in the form of Rural, Housing and Wholesale (as against Retail and Wholesale earlier).

Investment Rationales:

Loan growth to remain lower in FY17E due to decline in defocused book, likely to improve in FY18E:

LTFH has articulated its new business strategy for FY20 which is to improve ROEs to high teen by focusing on only high margin products. Hence post Q1FY17 we have seen 26% yoy and 11% decline in de-focused portfolio which includes Cars, Leases, MHCV, SCV, LCV, CE and SME Term Loans. We believe strategy of moving away from long term SME financing and CV, CE financing is a move in right direction as it will reduce risk of cyclicality of business. Hence focus on selective products in retail like Micro Financing, Vehicle financing, self employed home loan and Developer financing (selectively) will not only ensure sustainable growth but also better margins. As per management, overall Loan book is likely to grow by 15% in FY17E mainly due to run down of defocused portfolio and higher growth in few products in focused portfolio. However growth is likely to remain higher in FY18E as defocused portfolio will vanish completely.

LTFH’s new strategy has started to show its results from Q1FY17 itself as loan book in defocused book has de-grown by 26% yoy and 11% qoq and Focused book grew 23% yoy. We believe this is commendable performance despite large part of LTFH’s team was busy in integrating branches, moving their work places and closing their defocused book, they are able to deliver over all loan growth even on qoq basis. Further loan book composition is likely to change gradually by FY20 wherein retail (including housing) and wholesale will have equal proportion as against current 33% in retail, 50% wholesale and remaining defocused portfolio.