Published on 6/08/2020 11:47:16 AM | Source: Motilal Oswal Financial Services Ltd

Buy L&T Finance Holdings Ltd For Target Rs.85 - Motilal Oswal

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Strengthening the balance sheet

* L&T Finance Holdings (LTFH) reported 1QFY21 PAT of INR1.47b. However, excluding the INR2.25b one-time gain on the sale of the Wealth Management business to IIFLWAM, the company reported net loss of INR780m (v/s our PAT estimate of INR1.8b). While PPoP was 8% above our estimate, elevated provisioning of INR11.2b v/s our INR7b estimate has led to net loss.

* The company took additional INR5.8b COVID-19 provisions in the quarter (v/s INR3.1b in 4QFY20). As a result, the total contingency provision buffer (over and above NPA provisions) stands at INR12.4b (i.e., 1.4% of standard loans). In addition to 45bps of Stage 1 and 2 loan provisions, total standard asset provisions are now 1.8% of standard loans.

* As the company maintained higher liquidity on the balance sheet, it experienced a drag of INR850m net income. Reported fees and other income halved YoY to INR1.9b on lower rural/corporate disbursements.

* Importantly, moratorium rate on retail loans (in value terms) declined to ~35% in Jun’20 from ~75% in Apr’20. Moratorium on wholesale loans was ~40%. The share of customers who were granted moratorium as of 30th Jun’20 comprises: MFI – 48%; farm – 18%; TW – 33%; CL – 19%; HL/LAP – 33%; and RE, Infra, and IDF – ~40%. In corporate lending, performance has been divergent – toll collections / builder loan collections reached 80%/33% of pre-COVID-19 levels in June.

* Building a provision buffer in such times is definitely a prudent strategy. We expect the company to continue to do so for the next two to three quarters, taking the standard asset provisions to 2.5–3% of loans. Hence, we cut our FY21 EPS estimate by 25%, but keep the FY22 estimate largely unchanged.


Rural – Building up the provision buffer

* While margins declined modestly due to higher liquidity on the balance sheet, the real impact on the topline came from lower fee income (65– 70% QoQ and YoY decline to INR320m).

* LTFH took INR3.74b one-time COVID provisions for this segment (i.e., ~65% of the total COVID-19 provisions taken for the quarter). As a result, the company recorded 6.3% credit costs over the past two quarters, compared with the average of 3.5–4%. Overall PCR improved to 93% QoQ from 77%; at the same time, LTFH now has INR7.6b contingency provisions in this book (i.e., 3% of loans).

* While quarterly disbursements were muted, monthly trends were encouraging – tractor disbursements were up 19% YoY in June in volume terms.


Housing Finance – Negative carry puts NIM under pressure

* The loan book was sequentially stable at INR270b. Margins shrank 75bp QoQ to 4%, weighed by higher liquidity.

* LTFH took INR1.85b COVID-19 provisions in the quarter v/s INR1.33b in 4QFY20. It now has INR4.4b contingency provisions in this segment (1.7% of loans).


Infra Finance sees stable quarter

* In this segment too, margins declined 70bp QoQ to 2.1%, weighed by liquidity. Fees halved to 0.4% of loans due to lower disbursements. Infra disbursements have been the key source of fees for the company historically.

* In the Infra division, Stage 1 and 2 assets worth INR3.4b (~1.1% of the book) received moratorium benefit.


Key highlights from management commentary

* In June, of the total demand of INR7.5b (incl. moratorium customers), LTFH collected 87–88%. Net Stage 3 loans in the Tractor segment are now at an alltime low of 0.26%.

* Tractor demand is likely to improve MoM, while 2W demand would be muted.

* The INR2.25b provisioning against a defocused account this quarter was for a large conglomerate. This account is now 100% provided for.


Other details

* The GNPL ratio improved 10bp QoQ to 5.2%, driven by a 35bp QoQ improvement in rural lending GNPA at 3.4%. PCR increased to 69% from 59% in 4QFY20.

* The company had liquid assets of INR91b on the balance sheet and an additional INR76b worth of undrawn lines.

* While avg. AUM in the AMC segment was down 18% QoQ / 20% YoY to INR584b, equity AUM declined 18% QoQ / 25% YoY. After several quarters, PAT declined to INR500m v/s the average run-rate of ~INR600m.

* Cost of funds increased 6bp QoQ to 8.5%. The borrowing mix was largely stable sequentially.


Valuation and view

LTFH’s key retail businesses have witnessed an improving trend month-on-month in terms of both disbursements and collections/moratorium. Over the past two quarters, the company has been strengthening its provision buffer – standard asset provisions now stand at INR16b (i.e., 1.8% of standard loans). While this may be adequate for any potential asset quality shocks, we expect management to be prudent and continue to make contingency provisions over the next two to three quarters. While the company is able to raise debt at attractive prices given its parentage, we expect the drag on NII to continue due to higher liquidity. LTFH has focused on consolidating its loan book. The overall loan book has been largely flat and is expected to remain so for the next few quarters. Furthermore, the proposed consolidation of lending subsidiaries would simplify the business structure. The AMC business has done well over the past three years and contributed 10%+ to consolidated PAT in FY20. We believe this business would continue to grow at a faster pace than the lending segments in the medium term. We cut our FY21 EPS estimate by ~25% on the back of: a) lower NII due to excess liquidity and b) higher credit costs from building the contingency provision buffer. Our FY22 estimate remains unchanged. Maintain Buy, with TP of INR85 (1x FY22E BVPS).


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