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Rural MFI pain to hurt for a few quarters; downgrade to REDUCE

LTF reported a mixed Q2FY25 result with PAT of Rs6.96bn broadly in line with our estimates, whereas it was ~3% above Consensus estimates. However, on the asset quality and credit cost front, the difficulties have started to emerge with: 1. Credit cost (on AuM) jumped by 36bps QoQ to 2.86% and was the highest in 8 quarters; 2. GS3 increased by 5bps QoQ to 3.19%, while NS3 jumped by 17bps QoQ to 0.96%, reflecting ~5ppts QoQ reduction in PCR to 70%; and 3. MFI disbursements declined 5% YoY (first YoY decline in the last 15 quarters). We see the pain in MFI segment in terms of asset quality and credit cost (despite the Rs9.8bn macro-prudential buffer) affecting overall growth and profitability meaningfully over the next few quarters. We have cut our FY25-27E EPS by 10-13% and downgrade the stock to REDUCE from Add with our revised Sep-25E TP of Rs150 (vs Rs210 earlier), implying FY26E P/ABV of 1.4x.

Q2FY25 results a mixed bag

Supported by improved Opex, LTF reported a broadly in-line PAT at Rs6.96bn. However, beyond this in-line profit, the results point to a number of weaknesses and challenges on the asset quality and credit cost front. GS3 inched up by 5bps QoQ to 3.19%, while NS3 jumped by 17bps QoQ to 0.96%, reflecting a 5ppts QoQ decline in Provision Coverage Ratio (PCR) to 70%. The PCR remains healthy, but a 5ppts decline in PCR and credit cost (on AuM) jumping by 36bps QoQ to 2.86% indicate a higher level of write-offs. Led by strong growth in 2W, SME, LAP, and Home Loan disbursements, overall retail disbursements grew 12% YoY/1.7% QoQ to Rs151bn, whereas Rural/MFI disbursements declined 5% YoY/5% QoQ to Rs54.3bn.

MFI challenges to impact growth and profitability over the coming quarters

This is the first time in the last 15 quarters that the disbursements in MFI segments have declined YoY (5%). Along with the declining disbursements, the higher write-offs and inching up of GS3 suggests rising stress in the MFI book. The management appears confident that the pain in their Rural/MFI book is limited and shall bottom out by Q3FY25- end as their risk management guardrails were in place much before MFIN (MFI industry body) recommended prudent practices for the industry in Jun-24. We acknowledge that the company is sitting on Rs9.8bn macro-prudential buffer on the MFI book; however, given that the company has 30% of retail AuM in the Rural/MFI segments which generates substantially higher profit, we see a substantial impact on its growth and profitability over coming quarters due to the MFI stress. Ex-MFI, the business continue to do well but profitability of these businesses are still sub-par.

We cut FY25-27E earnings by ~10-13%; downgrade to REDUCE

To reflect the Q2 results and the external developments in MFI segments, we have adjusted our disbursement and AUM growth estimates downwards and increased credit cost estimates, leading to a ~10-13% EPS cut over FY25-27E and ~150bps RoE cut over FY26-27E. We downgrade the stock to REDUCE (from Add) with our revised Sep-25E TP of Rs150 (from Rs210 earlier), implying FY26E P/ABV of 1.4x. Recent correction in share prices have limited further downside in the stock.

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