Buy L&T Finance Ltd For Target Rs. 185 By JM Financial Services
In-line quarter
L&T Finance (LTF) reported an in-line quarter, with PAT increasing modestly (+2% QoQ, +15% YoY, in-line JMFe), while RoA moderated slightly to 2.17% (-5bps QoQ). Credit costs, though lower sequentially, remained elevated at 2.5% (-4bps QoQ), largely due to stress in the MFI, PL, and 2W portfolios. Additionally, LTF utilized INR 3bn from its macro-prudential provisions (current outstanding provisions of INR 5.75bn), which, when adjusted, results in an effective credit cost of 3.8%. Credit costs are expected to remain elevated through H1FY26, with gradual improvement anticipated afterward. Growth remained soft (+3% QoQ) as disbursements remained weak (-3% YoY, -2% QoQ) led by slowdown in retail finance (-1% YoY, 2% QoQ) primarily in rural business loan (-30% QoQ) and 2W (-23% QoQ) segments. This contributed to a decline in yields to 14.9% (-16bps QoQ) and subsequently margin compression to 8% (-65bps QoQ). Mgmt. has guided for loan growth of 20-25%, NIM + fees to be in the range of 10-10.5% and credit cost of 2.3-2.5% in FY26. Regarding the TN ordinance, mgmt. expects the impact to be short-term, similar to the Karnataka ordinance, with a disruption lasting 3-4 months, after which collection efficiencies are expected to stabilize. While stock currently trades at inexpensive valuations of 1.3x FY27E BVPS for avg. RoA/RoE of ~2.6%/13% over FY26/27E, company’s previous challenges with asset quality remain a key risk factor. We believe that a meaningful re-rating of the stock will depend on a) successful execution of the strategy to shift towards prime and near-prime customers while maintaining returns, b) realization of operating leverage through strategic technology investments, and c) effective management of credit costs, particularly through the rollout of proprietary AI-ML underwriting across all segments. We maintain BUY with a target price of INR 185 (valuing company at 1.5x FY27E BVPS).
* Disbursements remain muted; growth remains soft: Disbursements remained weak (-3% YoY, -2% QoQ) led by slowdown in key segments such as retail finance (-1% YoY, 2% QoQ) primarily in rural business loan (-30% QoQ) and 2W (-23% QoQ) segments. As a result, overall growth trends remained soft, with a 3% QoQ increase. Within the retail book, growth was driven by SME finance (+12% QoQ), followed by LAP (+8% QoQ) and home loans (+6% QoQ). Conversely, wholesale book contracted (-11% QoQ, -53% YoY). Rural business/MFI loans remained flat sequentially, while 2W segment showed modest growth (+5% QoQ). Additionally, LTF has expanded into gold loans through a slump sale agreement with Paul Merchants Finance Pvt. Ltd. Mgmt. guides for overall loan growth of 20-25%, with MFI growth projected in the range of 15-20%. We build in AUM CAGR of 19% over FY25-27E.
* Margin remains under pressure: Operating performance remained muted (-1% QoQ, +3% YoY) on the back of decline in NII (-5% QoQ, +1% YoY). PPoP was partially supported by a 5% QoQ reduction in operating expenses, which led to a favorable decline in the cost-to-assets ratio to 3.4% (vs. 3.7% QoQ). Mgmt. expects further operating efficiencies, particularly in collections and credit administration, led by implementation of Project Cyclops. Yields slipped to 14.9% (-16bps QoQ), reflecting slower growth in high-yielding unsecured assets. Consequently, margins continued to face pressure, falling by 65bps QoQ. Looking ahead, mgmt. has guided for NIM + fees to be in the range of 10-10.5%.
* Asset quality headwinds continue: GS3/NS3 further deteriorated to 3.29%/0.97% (+6bps QoQ, flat QoQ), with PCR at 71%. While credit costs showed a slight sequential improvement, they remained elevated at 2.5% (-4bps QoQ), primarily driven by stress in the MFI, PL, and 2W portfolios. Additionally, LTF utilized INR 3bn of macro-prudential provisions, leaving an outstanding balance of INR 5.75bn. Adjusting for this, credit costs would have been 3.8%. We expect credit costs to stay elevated through H1 FY26, with gradual moderation expected thereafter. Following the successful implementation of Project Cyclops 2.0 in its 2W portfolio, mgmt. is now rolling out the initiative in farm equipment segment, with plans for PL in 1QFY26 and SME finance in 2QFY26. These efforts are expected to support a reduction in credit costs over time. We build in avg. credit costs of 2.3% over FY26E-27E.
* Valuations and view: While stock currently trades at inexpensive valuations of 1.3x FY27E BVPS for avg. RoA/RoE of 2.6%/12.9% over FY26E-27E, the company’s previous challenges with asset quality remain a key risk factor. We believe that a meaningful rerating of the stock will depend on a) successful execution of the strategy to shift towards prime and near-prime customers while maintaining returns, b) realization of operating leverage through strategic technology investments, and c) effective management of credit costs, particularly through the rollout of proprietary AI-ML underwriting across all segments. We maintain BUY with a target price of INR 150 (valuing company at 1.5x FY27E BVPS).
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SEBI Registration Number is INM000010361
