L&T Finance Holdings rating – Buy: Sale of mutual fund business to make balance sheet stronger

Valuation is reasonable; deal in keeping with firm’s strategy; it is in a position now to focus on loan book growth; ‘Buy’ retained

L&T FinancE Holdings (LTFH) has entered into a definitive agreement with HSBC AMC, in which the latter will acquire 100% stake in L&T Investment Management (LTIM), the investment manager of L&T Mutual Fund (LTMF), for $425 m. In addition, LTFH will be entitled to excess cash (Rs 5-7 bn) in LTIM’s books until the completion of this divestment/acquisition. Including the excess cash (except the minimum cash requirement of Rs 0.5-1 bn) that LTFH is entitled to, the total sale consideration would be Rs 37-39 bn (4.6-4.8% of current AUM).

HSBC AMC would merge its existing Asset Management business (Sep’21 AUM of Rs 117 bn) with that of LTMF (Sep’21 AUM of Rs 803 bn). Subject to all regulatory approvals, LTFH expects this transaction to be completed within the next 9-12 months (i.e. by Dec’22).

Consequent to its last rights issue in Feb’21, wherein LTFH raised Rs 30 bn, its capital adequacy is at a healthy ~25% (Tier I: 20%). While the sale of the Asset Management business will take another 9-12 months to be consummated, we believe LTFH will utilise the proceeds primarily for risk capital (improving the provisioning cover) and only a small portion for growth capital (given its already healthy capital adequacy). Alternatively, part of the gains from this transaction could also be paid out as dividends.

As highlighted earlier, LTFH is near the bottom in terms of consolidation of its loan book and should start exhibiting loan growth in H2FY22E. NPA recognition of a large Real Estate account in Q2FY22 has removed an overhang of potential asset quality stress and will allow LTFH to work towards its resolution. We have not made any changes to our estimates (as yet) and factor in a 7%/11% loan growth in FY23E/FY24E. We maintain our Buy rating with an unchanged TP of Rs 110 per share (1.2x Sep’23e consolidated BVPS).

Did LTFH get a fair valuation for its Asset Management business?
Among listed peers, UTI AMC, with an AUM of Rs 2.3 trn, is the closest to L&TMF at Rs 812 bn. In terms of market capitalisation-to-AUM ratio, UTI AMC trades at 5.6%, whereas P/E on an annualised H1FY22 earnings stands at 18.2x. As per the deal contours, L&TMF’s assets have been valued at 4.6% of AUM and 19.3x annualised H1FY22 P/E, which appears reasonable.

Sensitivity analysis: Impact on EPS, book value, and capital adequacy
The divestment of the MF business will result in an extraordinary EPS of Rs 7.6 in FY23E. Ceteris paribus and assuming the entire proceeds from the sale of the MF business is retained for growth and risk capital, this will increase BVPS by 6-8% and CRAR by 150-190bp over FY23-24E.

Valuation and view
Divestment of the Asset Management business to HSBC AMC is in line with LTFH’s objective of unlocking value from its subsidiaries and strengthening its Balance Sheet for the Lending business. Given its healthy capital adequacy of over 25% and expected proceeds from the sale of the MF business, LTFH is now in a position to aggressively push forward towards its stated long-term goal of retailisation of its lending portfolio.

We reiterate our view that LTFH is near the bottom in terms of consolidation of its loan book, with an expected pick-up in infra disbursements and Retail Housing/LAP. Even though we remain watchful of potential slippages in Real Estate Finance in H2FY22, given the buoyancy in the Real Estate sector, we expect resolutions of such exposures to be relatively quicker.

LTFH carries adequate additional provisions (including OTR provisions) of 2.2% of standard loans. These are over and above ECL provisions and should provide the necessary buffer to protect against contingencies in Micro loans and the Real Estate segment. We have not made any changes to our estimates (as yet) and maintain our Buy with an unchanged TP of Rs 110 (1.2x Sep’23E consolidated BVPS).