L&T Finance's high valuations unsustainable: Experts

Despite its healthy growth and prospective banking licence, current valuations leave little room for any negative surprises on the asset quality and regulatory fronts

Given its diversified presence across retail and corporate lending segments, strong parentage and good financial performance, L&T Finance Holdings’ business growth is on track. The lender is touted to be a leading candidate to get a banking licence. Not surprisingly, its stock has outperformed the benchmark Sensex in the past three months as the Banking Amendment Bill was cleared by Parliament. After this rally, the L&T Finance Holdings’ stock is trading at Rs 93 a share and valuations appear to adequately capture its future prospects. Investors can use any correction in the price as an entry point in the stock, according to analysts.

“L&T Finance Holdings is a front-runner to gain a banking licence, though this is still 6-12 months away given that banking licence process will take its own time. Current multiples look unsustainable, hence we downgrade from ‘buy’ to ‘sell’,” says Santosh Singh, analyst at Espirito Santo Securities. He has a target price of Rs 64 on the scrip.

Banking licence: challenges and prospects
L&T Finance Holdings’ strong brand name, large size and diversified loan portfolio make it a leading candidate for a banking licence. Peers such as Mahindra & Mahindra Financial Services and Shriram Transport Finance Company are also touted as the front-runners for the banking licence. Currently, the L&T Finance Holdings scrip is trading at 2.6 times FY14 estimated book value, closer to that of M&M Financial, but higher than Shriram’s price/book value of 1.9 times.

HEALTHY GROWTH
In Rs  crore	FY12	FY13E	FY14E
Net interest income	1,196	1,643	2,044
Y-o-Y change (%)	12.2	37.4	24.4
Net interest margin (%)	5.7	5.9	5.9
Y-o-Y change (bps)	180	20	-
Net profit	455	608	802
Y-o-Y change (%)	14.2	33.6	32.0
Loan growth (%)	43.0	25.2	23.5
ROE(%)	11.9	12.0	13.9
ROA(%)	2.0	2.0	2.2
E: Estimates                                                       Source: Analyst reports

Experts say that while the banking licence will be a key positive for the company going forward, there will be quite a few challenges in the medium term. The key ones would be meeting with stricter regulations (on priority lending, provisioning), having at least 25 per cent of branches in unbanked areas and creating a strong Casa (current account, savings account) base.

SUM OF THE PARTS
In Rs  crore	Valuation	Value per share
L&T Finance	5,602	32.7
L&T Infra Finance	4,469	26.1
L&T Mutual Fund Investments	360	2.1
Federal Bank	481	2.8
City Union Bank	115	0.7
Total Valuation		64.4
Source: Espirito Santo Investment Bank Research, Company Data

Thus, the new banks will need to incur significant costs initially, which could dilute their near-term profitability. According to experts, L&T Finance Holdings’ current valuations do not factor in these challenges.

Loan growth strong, asset quality woes
While L&T Finance Holdings’ loan growth is expected to moderate from 43 per cent levels witnessed in FY12, it will still be in a healthy range of 23-25 per cent over FY12-15, say analysts. The company is expected to post earnings growth of 28 per cent over this period. The return on equity (RoE)s will be driven higher by retail business at 18 per cent, while that of its corporate business is likely to moderate to 15-16 per cent levels. L&T Finance Holdings recently acquired two companies - Indo Pacific Housing Finance (IPHF) and FamilyCredit in the housing and auto lending businesses, respectively. Going forward, both these acquisitions will drive growth of its retail business subsidiary L&T Finance.

While asset quality trends have improved in its retail business, L&T Finance Holdings’ corporate business has witnessed higher slippages in the recent quarters. Analysts remain cautious on this front and expect its credit quality to be under pressure due to its high infrastructure exposure and delay in implementing projects. “We expect L&T Finance Holdings’ credit cost to increase by 52 per cent in FY13 and 35 per cent between FY12 and FY15. Positively, lower provisions on the micro-finance business will likely pull down its provisioning cost, leading to lower credit costs to average assets ratio for its retail business L&T Finance,” says Nischint Chawathe, banking analyst at Kotak Institutional Equities.