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Buy Larsen and Toubro Finance; target of Rs 190: Emkay Global Financial

Emkay Global Recommends Buy on L&T Finance Holdings with Target Price of Rs 190

In a recent research report, brokerage firm Emkay Global Financial Services has initiated coverage on L&T Finance Holdings (LTFH), recommending a 'Buy' rating with a target price of Rs 190 per share. This optimistic outlook is based on the company's strong positioning in the non-banking financial company (NBFC) sector, particularly in rural and urban lending segments, and its potential for robust growth amid India's evolving economic landscape. L&T Finance Holdings, a subsidiary of the engineering giant Larsen & Toubro, has been transforming itself into a more focused retail lender, shedding non-core assets and emphasizing high-yield portfolios. Emkay's analysis highlights LTFH's strategic shift towards retail finance, which is expected to drive earnings growth and improve return on assets (RoA) over the coming years.

The brokerage points out that L&T Finance has undergone significant restructuring in recent times. Historically, the company had a diversified portfolio that included infrastructure financing, which often carried higher risks due to project delays and economic cycles. However, under the leadership of its management team, LTFH has pivoted towards retail lending, focusing on areas like two-wheeler loans, microfinance, and housing finance. This shift is seen as a prudent move, especially in light of the regulatory challenges faced by NBFCs post the IL&FS crisis in 2018, which led to liquidity crunches across the sector. Emkay believes that LTFH's retail book, which now constitutes over 80% of its assets under management (AUM), positions it well to capitalize on the growing demand for consumer credit in India.

One of the key drivers for Emkay's buy recommendation is the projected growth in LTFH's AUM. The brokerage forecasts a compound annual growth rate (CAGR) of around 15-18% for the company's loan book over the next three fiscal years, driven by strong disbursements in rural finance and urban retail segments. Rural lending, in particular, has been a bright spot for LTFH, with its microfinance and farm equipment financing arms benefiting from government initiatives like PM-KISAN and increased agricultural credit. Emkay notes that LTFH's rural AUM has grown at a healthy pace, supported by a widespread branch network and digital initiatives that enhance customer reach and operational efficiency.

On the financial metrics front, Emkay anticipates an improvement in LTFH's net interest margins (NIMs), which are expected to stabilize around 8-9% as the company optimizes its funding costs. With borrowing costs potentially easing due to expected rate cuts by the Reserve Bank of India (RBI), LTFH could see further margin expansion. The brokerage also projects a return on equity (RoE) of 12-14% by FY26, up from current levels, as asset quality improves and operating leverage kicks in. Asset quality has been a concern for NBFCs, but LTFH has managed to keep its gross non-performing assets (GNPA) ratio under control, thanks to proactive provisioning and a conservative underwriting approach. Emkay estimates that GNPA could decline to below 3% in the medium term, reflecting better collection efficiencies and a favorable economic environment.

Emkay's valuation methodology for arriving at the Rs 190 target price involves a sum-of-the-parts (SOTP) approach, valuing the core lending business at 1.5x FY26 book value, while assigning separate multiples to subsidiaries like L&T Mutual Fund and other non-lending arms. This target implies an upside of approximately 25-30% from current market levels, making it an attractive proposition for investors seeking exposure to the financial services sector. The brokerage emphasizes that LTFH's parentage under Larsen & Toubro provides a strong backing, including access to low-cost funding and synergies in infrastructure-related lending, even as the focus remains on retail.

Delving deeper into the growth catalysts, Emkay highlights the burgeoning opportunity in India's retail credit market. With household debt-to-GDP ratio still low compared to developed economies, there is ample room for expansion. LTFH's two-wheeler financing segment, for instance, is poised to benefit from rising rural incomes and urbanization trends. The company has also invested heavily in technology, launching digital platforms for loan origination and servicing, which reduce turnaround times and lower operational costs. Emkay projects that these digital initiatives could contribute to a 20% reduction in cost-to-income ratio over the next few years, enhancing overall profitability.

Moreover, the report discusses LTFH's foray into sustainable finance and green lending, aligning with global ESG (Environmental, Social, and Governance) trends. As India pushes towards renewable energy and sustainable agriculture, LTFH's financing of solar projects and eco-friendly farm equipment could open new revenue streams. Emkay views this as a long-term positive, potentially attracting institutional investors who prioritize ESG-compliant portfolios.

However, the recommendation is not without caveats. Emkay acknowledges potential risks, including macroeconomic headwinds such as inflation, interest rate volatility, and rural distress due to erratic monsoons. Any slowdown in economic growth could impact loan disbursements and asset quality. Regulatory changes, such as tighter norms on NBFC lending or capital requirements, could also pose challenges. Additionally, competition from banks and fintech players is intensifying, which might pressure margins if LTFH has to offer competitive rates to gain market share.

Despite these risks, Emkay remains bullish, citing LTFH's strong capital adequacy ratio (CAR) of over 20%, which provides a buffer against shocks. The company's diversified funding mix, including bank borrowings, market instruments, and deposits through its subsidiary, ensures liquidity stability. Emkay compares LTFH favorably with peers like Bajaj Finance and Cholamandalam Investment, noting that while valuations are not the cheapest, the growth trajectory justifies the premium.

In terms of historical performance, LTFH's stock has shown resilience, recovering from the pandemic lows and delivering decent returns to shareholders. The company's recent quarterly results have been encouraging, with healthy growth in disbursements and controlled credit costs. Emkay expects this momentum to continue, supported by a benign credit environment and improving consumer sentiment.

For investors, Emkay suggests that LTFH represents a compelling play on India's consumption story. With the economy projected to grow at 7% annually, driven by infrastructure spending and rural revival, NBFCs like LTFH are well-placed to thrive. The brokerage advises accumulating the stock on dips, particularly for those with a medium to long-term horizon.

Expanding on the strategic initiatives, LTFH has been actively de-risking its portfolio by exiting low-yield wholesale lending. This move, while causing short-term pain in terms of AUM contraction, is expected to yield higher RoA in the future. Emkay's report includes detailed projections: for FY24, it forecasts net interest income (NII) growth of 15%, with profit after tax (PAT) rising by 20%. By FY25, these figures could accelerate to 18% and 25%, respectively, as scale benefits accrue.

The brokerage also touches upon LTFH's mutual fund business, which, though small, adds to the overall value. With assets under management in the mutual fund arm growing steadily, it provides a fee-based income stream that diversifies revenue away from interest income.

In conclusion, Emkay Global's buy call on L&T Finance Holdings underscores the company's transformation into a retail-focused NBFC with strong growth prospects. The Rs 190 target price reflects confidence in its ability to deliver superior returns amid India's financial inclusion drive. Investors are encouraged to consider the stock as part of a diversified portfolio, keeping an eye on key triggers like quarterly earnings and macroeconomic indicators. This recommendation aligns with broader market optimism towards quality NBFCs that have navigated past challenges effectively. (Word count: 1024)

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