Sharekhan Research has issued a BUY recommendation for L&T Finance Holdings Ltd (LTFH) with a target price of Rs. 200, highlighting robust performance despite challenges in the Microfinance (MFI) segment. The report underscores solid growth in retail assets, driven by home loans, SME financing, and loan against property (LAP). However, the MFI segment is grappling with regulatory headwinds and overleveraging issues. Despite these challenges, LTFH's operational resilience is noted, alongside strong profitability indicators. The current market price (CMP) stands at Rs. 158, and the stock trades at an attractive valuation.

Key Points from Q2FY25 Results

Net Interest Income (NII) and Margins:
NII grew by 18.1% year-over-year (y-o-y) and 3.7% quarter-over-quarter (q-o-q) to Rs. 2,178 crore, slightly missing estimates by 1.6% due to higher funding costs. The net interest margins (NIM) were at 9.59%, slightly below expectations by 16 basis points (bps).

Retail Segment Growth:
LTFH’s retail loan portfolio witnessed a robust 28% y-o-y and 5.4% q-o-q growth, driven by segments like two-wheeler loans, home loans, and SME finance. Disbursements amounted to Rs. 15,162 crore, with notable growth in urban and SME segments, while MFI and rural finance showed muted performance.

Profitability and Operating Efficiency:
Operating profit before provisions (PPOP) grew by 21.4% y-o-y and 15.9% q-o-q, supported by higher other income and cost efficiencies. However, provisions increased by 24.8% y-o-y, reflecting the strain on the MFI segment.

Challenges in the MFI Segment

The MFI sector remains a point of concern due to regulatory challenges, overleveraging, and weather disruptions. The Gross Stage 3 (GS3) assets, which indicate stressed loans, slightly increased to 3.19% from 3.14% in the previous quarter. This reflects the difficulties in the MFI industry, which accounts for 28.5% of LTFH’s total loan portfolio.

Management remains optimistic about a recovery in H2FY25, driven by favorable agricultural outputs and adjustments in credit underwriting filters to prioritize non-leveraged customers. The company’s efforts to navigate these challenges include a strengthened focus on collections and risk mitigation.

Key Positives

Retail Portfolio Resilience:
Despite sectoral headwinds, the retail portfolio delivered strong growth, particularly in home loans, LAP, and SME finance, which collectively supported LTFH’s overall performance.

Operational Efficiency:
Operating expenses declined by 5.6% q-o-q, while other income grew by 17.7% y-o-y, driving profitability even amidst rising credit costs in the MFI segment.

Strong Collection Efficiency:
LTFH maintained a strong collection efficiency of 99.4% in September 2024, reinforcing its ability to manage stressed portfolios effectively.

Management Outlook

LTFH’s management is targeting a Return on Assets (RoA) of 2.8-3.0% by FY26, with credit costs expected to stay within 2.0%. The company is also prioritizing prime customers in its retail portfolio and has introduced stricter filters for the MFI segment to improve credit quality.

A notable development is the launch of the beta version of Cyclops, a next-generation credit underwriting engine, which enhances credit decision-making processes. This technology has already been implemented in 55% of two-wheeler dealerships, showing promising results and expected to be rolled out across other business lines by the end of FY25.

Valuation and Target Price

Maintain BUY with a Price Target of Rs. 200:
LTFH is expected to benefit from its focus on retail growth, technological advancements, and strategic realignment of its business mix. The stock currently trades at 1.4x/1.3x its FY25E/FY26E book value, and with a P/E of 15.4x for FY25, it remains attractively valued. Sharekhan maintains a BUY rating, given the company's healthy growth prospects and robust asset quality management.

Stock Performance and Risk Factors

Stock Price Performance:
LTFH’s stock has underperformed in recent months, with a 10.7% decline over the past one month and a 14.4% decline over the past three months. Despite these setbacks, the stock has gained 19.2% over the past year, reflecting its resilience in the long term.

Risks to Watch:
The MFI segment remains the primary risk for LTFH. Higher-than-expected slippages in this portfolio could lead to elevated credit costs and pressure on profitability. Additionally, slower growth in the retail portfolio or further regulatory challenges in the MFI space could impact the company’s overall performance.

Conclusion

L&T Finance Holdings continues to showcase resilience despite challenges in the MFI sector, supported by its strong retail loan growth, improved operational efficiency, and prudent risk management strategies. With a BUY rating and a target price of Rs. 200, LTFH offers an attractive opportunity for investors, particularly those seeking exposure to India’s growing retail finance sector. The company’s ongoing investments in technology and credit underwriting capabilities position it well for sustainable growth in the medium to long term.