L&T Finance Holding:Buy,1QFY18

LTFH reported a good 1QFY18 with a PAT of INR3.1bn, growing 49% YoY. CoreRoE improved 200bps YoY to 15.8%, while overall RoE (including defocused book)improved 380bps YoY to 13.6%, driven by shrinking loss-making loan book, robustdisbursal growth in focused segments and cost efficiencies.

    Key highlights: 1) Loan disbursals grew at 96.3% YoY in 1Q, due to pick up intractors, developer finance and infra finance. However, loan growth stood at 17% YoYdue to significant repayments, especially in the rural book. 2) Consolidated marginsremained stable at 5.34%. 3) Fee income continued its strong traction, growing 177%YoY. Higher debt capital market participation and higher sell-downs of underwrittenloans were the key drivers of this growth and this momentum is likely to continue. 4)Operating efficiencies have stabilised at Cost/Assets ratio at 1.7% (flat QoQ anddown 30bps YoY). They have reached a sustainable level of cost efficiencies and shouldhold on to the gains. 5) On asset quality, LTFH moved to 90-day NPL recognitionnorms in 1Q, which led to an 18% QoQ increase in NPLs. GNPL ratio deterioratedfrom 4.94% to 5.71%, while provision cover improved marginally to 43.4%. RuralGNPL ratio jumped to 11.35% and wholesale total impaired assets stood at 9.6%versus 4.3% GNPL ratio. While rural NPL coverage stood at 35.6%, wholesale bookstressed asset coverage is still low at 27.6%. Management is on track to increase theprovision coverage to ~50% during the current fiscal year. 6) The asset managementbusiness continued to do well with AUM growing 57% YoY. Operating leverage isalso kicking in now, leading to 9.5% RoE from 3.5% YoY.

    Outlook: LTFH continues to track well on growth and profitability, though we hadexpected higher provisions towards infra stress during 1Q. Overall, we maintain our18-20% loan growth outlook as well as expectations of ~18% RoE by FY19e. Wemaintain our FY18-19 estimates and introduce our FY20 estimates in this note.

    Valuations: At the current market price, LTFH trades at 3.2x 12-mth forward P/AB.

    Based on our Economic Profit Model (EPM), we now value the stock at INR184(INR163), mainly due to the roll-forward of our EPM value and higher value for theasset management business due to better-than-expected business traction. Weretain our Buy rating. Key downside risks: 1) wholesale book RoE struggles torecover; 2) microfinance and two-wheeler potential defaults; 3) slower loan growth.