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Transforming digitally; valuations inexpensive - Upgrade to BUY

We attended L&T Finance’s (LTF) digital investor day where the management articulated its digital transformation journey and its way forward to drive stringent operations and stabilize credit quality led by Project Cyclops, an AI-driven, multi-dimensional underwriting engine. The company has made significant efforts to improve its credit underwriting practices across different product lines and has created an omni-channel digital architecture to support steady growth. We remain circumspect on MFI exposure for LTF (30% MFI book exposure) though it is relatively well placed given the company had been tightening its belt well in advance and it has exposure of only 5% (INR 12.5bn) of its MFI book to customers with high leverage (>=4 associations). LTF also maintains additional macro-prudential provisions of INR 9.7bn on its MFI book (~3.7% of total MFI loans) which insulates from any future shocks. LTF has assigned a fresh sourcing vertical with a team of 500+ members to acquire lower leveraged customers which would ensure continued and healthy growth in the segment. We believe the recent correction of ~ 16% in last 3 months led by issues across MFI industry offers significant upside from here. The current valuations of 1.2x FY26E P/B are relatively inexpensive in return for RoAs/RoEs of 2.7%/13.4%. We upgrade the stock to BUY with a TP of INR 180, assigning a target multiple of 1.6x FY26E BVPS.

* Strong aspirations from digital initiatives: LTF demonstrated Project Cyclops, an AI-ML based in-house credit intelligence tool, which is gradually being integrated into various lines of businesses. The company highlighted multiple applications of Cyclops via different use cases and alluded on how the company underwrites and processes these loans digitally. Project Cyclops is being implemented for 2W and farm equipment segments (Exhibit 1-5) and is expected to be completed by Jan’24. It will be launched for PL segment by FY25 end. The company has spent a total of INR 1.25bn in FY24 and expects INR 1.75bn opex in FY25 on Project Cyclops (total of ~0.4% of AUM). On the asset quality side, company is working on early warning signals to detect possible defaults on time. It is an emerging stress simulation system named Nostradamus (Exhibit 8) which will also be used to quantify the risk associated with every proposal. The company had launched PLANET app in FY22 (D2C platform) which has aided in strong growth in its retail business and it has launched 2 versions of the app since then. It plans to launch PLANET3.0 (Exhibit 9-11) in near term with a completely revived backend system. This tech integration has lowered the avg sanction TAT meaningfully for the company from 15min or days to just 15-30 seconds. With AI and Gen AI (Exhibit 6-7) introduction to the product lines via Cyclops, we believe that this also opens up opportunities for the company to lend to informal customers with taking multiple parameters into consideration and within a short period of time

* Relatively well placed in MFI segment (accounting for ~30% of total book): LTF moderated disbursements to few states basis collection thresholds which led total disbursements to decline from INR 19.2bn in Jul’24 to INR 14.9bn in Oct’24. As of Oct’24, LTF had ~8% of its customers with more than three lenders and ~5% of customer with over four lenders. ~0.3% of customers had more than six lenders (down from 0.5% in Jun’24). ~69% of the total MFI book is either “only LTF” customers or “LTF+1” customer which provides confidence on the product segment of the company. LTF has assigned a dedicated fresh sourcing vertical with a team of 500+ members to acquire lower leveraged customers which would ensure continued and healthy growth in the segment. It is evaluating new geographies like Maharashtra, Tamil Nadu, Andhra Pradesh and Uttar Pradesh where the customer leverage is low. Despite the stress in the system, collection efficiencies for the company has not been meaningfully affected as it stood at 99.3% in Oct’24 vs 99.4% in Sep’24. This shows resilience in the asset quality of the company’s MFI book and thus builds confidence on the credit underwriting practices. LTF has also rationalized field-officers APC from 540 to 490 to optimize span of control and improve monitoring. Management guides for credit cost to go up to 3.5-3.7% for FY25E on the back of emerging stress in the space, however, the additional management overlay of INR 9.7bn is expected to limit its credit costs to certain extent.

* Management guidance remains intact: Management targets sustainable RoAs of 2.8-3% going forward in line with Lakshya 2026 goals despite NIMs pressure and MFI stress. LTF aspires to double its loan book in next 3-4 years with 10.75-11% NIMs+Fees and 2- 2.25% steady state credit costs. Management aims to keep opex+credit costs in the range of ~7% despite new branch rollouts, marketing campaigns and new product launches.

* Valuations and view: We expect a) a steady growth at 24% AUM CAGR over FY24-26E, b) slight moderation in NIMs coming in from slower MFI disbursements and higher secured mix and c) strategic investments in IT and branch expansion for FY24-26E. We believe that the current valuations of 1.2x FY26E P/B are relatively inexpensive in return for RoAs/RoEs of 2.7%/13.4%. We upgrade the stock to BUY with a TP of INR 180, maintaining the target multiple of 1.6x FY26E BVPS.

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