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Fraught with challenges, recovery distant

Reflecting mixed earnings, L&T Finance’s (LTF) Q3 was marked by judicious business expansion, tech-led customer filtrations, collections ramp-up and drawdown on macro prudential provisions on the positive side. On the flip side, a tad distant recovery, persistent MFI stress, resultant elevated credit costs, weakening NIM+ fees stream, and recalibrated growth hurt earnings and return profile alike. While we closely monitor the benefits from sharpening underwriting through advanced tech implementation (cyclops – targeting PDs with rigorous customer screening), which is 2-3 quarters away, we do factor in near-term headwinds and thus, pare TP to INR 171 (from INR 200). Maintain Accumulate as valuations have corrected.

Macro provisions drawdown, a savings grace; near-term PAT pressures stay: In Q3, PAT declined 10% QoQ/2% YoY due to elevated provisions (up 42% QoQ) but the earnings fall was curbed by drawdown of macro provisions to the tune of INR 1bn of INR 9.8bn related to MFI stress, with anticipation of another INR 3.5bn in Q4. However, NII was a drag (up just 3% QoQ) on soft growth (16% YoY/2% QoQ) and NIM+ fees at 10.33% (missing guided corridor of 10.5-11%) on selective business expansion. Some breather in opex (down 21% QoQ) restricted the PPoP fall (up mere 6% QoQ/12% YoY), but cost-income was elevated at 40%, driven by festival season-led spend, ramp-up in collections and continued tech investments. With MFI recovery still distant and growth calibration underway, FY25-26 earnings will be strained, driving down RoEs.

Focus on de-risking balance sheet underway; growth to remain soft: In Q3, overall loan growth run-rate dropped to 16% YoY due to stress in MFI (28% of AUM), change in farm equipment business (16% of AUM) policy, flight to safety in two-wheelers (13%) and personal loan (8%) segments with incremental focus on prime/salaried customers. So, MFI disbursements slowed with quarterly run-rate dropping to INR 46bn from ~INR 56bn in the past year, compensated by guarded incremental disbursements run-up in farm equipment and two-wheelers. With persistent industry headwinds and cautionary stance, expect 14% YoY/19% growth in FY25E/26E, respectively

Credit cost to peak in Q4, recovery distant: LTF saw only slight slip-up in retail Stage 2 as collection efficiencies held up (0 dpd at 99.4% in Q3 versus 99.8% in Q3FY24, 0-90dpd at 97.9%), led by two counts: (a) high MFI concentrated states (Bihar, Karnataka, Tamil Nadu: ~58% of book) showing normalization signs (impact from Bihar floods behind) a (b) limited forward flows in non-MFI. But another INR 3.5bn drawdown on provision in Q4 for the same and MFI recovery being 2-3 quarters away would imply credit costs now settling to a new normal of 2.5-2.55%, NPAs averaging at 4%: FY25E-27E.

Near-term outlook gloomy: We trim FY26E/27E estimates by ~10% each on earnings pressure. Near-term pressure on growth should have a larger bearing on RoEs, the latter likely restricted to <12% and 12%+ in FY26-27E. So, despite stock correction, maintain Accumulate. We cut TP to INR 171 (from INR 200) valuing LTF at 1.3x FY27E PABV from 1.5x earlier. Conviction on new portfolio behavior may drive a rerating.

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