Investors with a time frame of over three years can invest in the stock of L&T Finance Holdings (LTFH). LTFH is a holding company, with subsidiaries that operate in retail finance, infrastructure finance and corporate finance segments.

At the current price of Rs 42.2, the stock trades at 1.4 times its estimated FY-13 book value (adjusted for NPAs). At this valuation, the stock looks attractive for the following reasons: one, its diversified lending book will protect it from any cyclicality in any specific business and support loan book growth.

Two, the return ratios are expected to improve as the gearing (increased use of debt) of its subsidiaries rises. Three, the company may arrest any further decline in margins, going forward, given the moderation in cost of borrowing.

Finally, from a long-term point of view, the company will be a significant beneficiary of issue of the banking licence.

A holding company structure (one of the requirements of the RBI), strong support from parent Larsen & Toubro, besides strong rural presence, make it a good candidate to qualify for a banking licence.

Diversified business

LTFH has a broad-based income stream arising from mutual fund products, wealth management services and infrastructure advisory services. The recently acquired Fidelity mutual fund’s large equity portfolio will complement its existing fund business which predominantly has debt portfolio.

While income from these streams is currently not significant, given the nascent stage of these businesses, they may well ramp up, providing LTFH with multiple revenue streams.

Loan book

LTFH has scaled up its loan book from Rs 6,600 crore in March 2008 to Rs 25,000 crore in March 2012. Most of the exposure is secure in nature. Infrastructure finance accounts for around 44 per cent of the consolidated loan exposure. Even in infrastructure finance, its exposure is well spread out with renewable energy accounting for a fifth of the infrastructure finance book.

Conventional power sector accounted for 25 per cent, while road and telecom accounted for a combined 23 per cent of the infrastructure book as of March.

Retail finance accounted for 32 per cent of the book. This segment primarily focuses on income generating activities such as construction equipment, transport equipment financing, rural financing (tractor and light commercial vehicle financing) and micro finance.

The rest of the exposure is to corporate loans, supply chain financing (includes suppliers of L&T) and capital market financing.

With acquisition of Indo-Pacific Housing Finance, the retail loan book may further deepen. This acquisition will also give LTFH access to low cost refinancing from National Housing Bank.

LTFH as a diversified NBFC would not have access to this refinancing on its own. LTFH will use this acquisition, together with its own strong presence in semi-urban and rural areas, to penetrate the housing finance market. As such, LTFH may seem like an overtly diversified NBFC. But as investors, you get exposure to focussed businesses housed separately in subsidiaries — L&T Finance, L&T Infrastructure Finance and L&T Fincorp.

Starting this fiscal, L&T Fincorp will take care of non-asset backed financing (supply chain financing) and SME financing while L&T Finance will focus on asset-backed financing.

Margins

The net interest margin of LTFH was 5.4 per cent for the year ended March 2012 down from 6.8 per cent a year ago, due to sharp rise in wholesale borrowing costs. But LTFH managed to pass through rise in costs to its customers from the March 2012 quarter. The margins during the March 2012 quarter improved to 5.9 per cent. Additionally, the interest rates on commercial paper have moderated by more than 200 basis points in the last three months. Similarly, select banks have reduced their lending rates post-RBI policy rate cut.

This will help them tap lower cost funds as their liability portfolio (borrowings from banks) is predominantly floating while the loan portfolio (other than infrastructure) is mostly fixed.

Asset quality

The micro finance segment is the only drag on the company’s book and has pulled down its profitability during the year. But, with the introduction of the MFI Bill in Lok Sabha, there is some hope of improving prospects outside Andhra Pradesh.

The net NPA ratio at the consolidated book is at 0.9 per cent (excluding micro finance slippages) as of March 2012. This is a healthy ratio for an NBFC. Once NBFC regulations are in place (dues over 90 days from the current regulation of 180 days), most NBFCs may see a jump in their NPA as a consequence of higher provisioning.

But LTFH has higher-than-required standard asset provisioning and fully provides for the sub-standard loans which are due more than 1.5 years. It also has 100 per cent provisioning for unsecured non-performing loans. Hence its profitability is unlikely to be impacted much on this front.

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