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Asset quality remains stable despite challenges in microfinance segment

Steady top-line growth:

L&T Finance reported a 3.65% (QoQ) and 18.1% (YoY) increase in net interest income, reaching Rs 2,178 crore, driven by robust growth in retail assets like LAP and Home loans. During the quarter, the cost of borrowing moderated by 5bps on QoQ to 7.8%, while other income saw a significant YoY growth of 17.9%. As a result of the healthy growth in retail finance business and other income growth, profit after tax (PAT) increased by 1.5% QoQ and 16.9% YoY, reaching Rs 696 crore.

Strong growth in retail AuM book:

Retail AuM increased by 5.4% QoQ/28.2% YoY to Rs 88,975cr which was led by healthy disbursement growth of 11.8% YoY to Rs 15,092cr. The company saw healthy growth in its loan book in segments such as SME Finance (16.1% QoQ/115.1% YoY), Urban Finance (7.6% QoQ/33% YoY), LAP (12.4% QoQ/58% YoY), Home loans (7.9% QoQ/38.6% YoY) while slowdown was seen in segment such as farmer finance (2% QoQ/8% YoY). Similar to loan book, the company saw healthy disbursement growth in LAP business (25.7% QoQ/95.5% YoY). Going forward, the company remains optimistic of its loan growth in FY25E and anticipates healthy growth in its loan book.

Focus on secured loans impacted NIMs:

During the quarter, the company reported a decline in its margins, with the NIM decreasing by 37 bps QoQ while on annualised basis it improved by 32 bps YoY. As the industry is currently facing some headwinds due to microfinance segment, the management has taken a cautious approach and has begun to focus more on secured assets which impacted its NIMs. The combined NIM and fee & other income declined by 22 bps QoQ and while improving marginally by 2bps YoY, driven mainly by healthy fee income. Looking ahead, the company has lowered its NIMs plus fee guidance from 10.75% - 11.25% ranges to 10.50% -11% range. Asset quality continues to remain robust: The Company’s asset quality largely remains stable despite stress seen in microfinance segment at industry level. As GS3 assets were in line at 3.2% increasing 5bps on QoQ while seeing a decline of 8 bps YoY. However, due to pressures in microfinance, particularly in regions like West Bengal, Bihar, and Gujarat, the company reported a credit cost of 2.6%, slightly above the guided range of 2% to 2.5%. Management anticipates that credit costs may stay elevated for several more quarters due to ongoing challenges in the microfinance sector.

Valuation and Outlook:

L&T Finance has demonstrated strong growth in its AuM, despite facing challenges in the microfinance sector. The company's NIMs remain robust at approximately 8.9%, as management adopts a cautious strategy and increases focus on secured products. This approach has allowed L&T Finance to maintain solid asset quality, outperforming its peers in the industry. However, due to current market challenges, growth expectations for the retail segment have been revised downward, while credit cost assumptions have been raised. As a result, we expect NII and PAT to grow at CAGRs of 13.6% and 10%, respectively, over the fiscal years 2024 to 2026. We maintain Buy rating on the company with a target price of Rs 197, valuing the company at 1.7x of its FY26E Adj. BV.

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