Investors can subscribe to the initial public offer of L&T Finance Holding (L&TFH). L&TFH, promoted by Larsen and Toubro, is a holding company for two fully owned non-banking finance companies (NBFCs) — L&T Infrastructure Finance and L&T Finance. Strong parentage, diversified and high quality loan book, superior interest spreads and sustainable demand in various segments of presence make it a good candidate for investment.

At Rs 59 (upper end of the price band), the valuations are at 2.2 times the consolidated FY-11 book, post-infusion. Based on sum-of-the-parts valuation, the issue price seems to offer a 11 per cent upside over the next one year. We have valued L&T Finance at Rs 37 per share, L&T Infra at Rs 25 per share, stake in Federal Bank, City Union Bank and L&T Mutual Fund at Rs 3.7 per share. We have assumed a slight premium for L&T Finance over its peers given its strong parentage, high degree of corporate governance, sound risk management and conservative provisioning. The long-term prospects of the company continue to remain attractive as we expect higher rate of growth and increased leverage. We, therefore, recommend that investors subscribe to the offer with a two-three year investment horizon.

Through this IPO and pre-IPO placement, the company will raise Rs 1,575 crore to support capital adequacy ratio of its subsidiaries and retire Rs 345 crore of inter-corporate deposit. The inter-corporate deposit was taken from Larsen and Tubro to support the capital needs of its subsidiaries last fiscal. Around Rs 570 crore (Rs 515 crore from the IPO) would go to L&T Finance and Rs 535 crore (Rs 485 crore from the IPO) towards augmenting capital of L&T Infrastructure Finance.

The capital adequacy ratio of L&T Finance was 16.3 per cent, while L&T Infrastructure Finance's ratio was 16.5 per cent. The management has noted that the current capital infusion and utilisation of the untapped Tier-2 capital would take care of the funding requirements over the next two years. Leveraging the loan book further would improve L&TFH's return on net worth.

L&TFH's consolidated loan book consists of three segments — corporate finance, retail finance and infrastructure finance. Infrastructure finance accounted for 41.4 per cent of the loan book and retail 38 per cent. Apart from lending operations, L&TFH has a mutual fund business (acquired from DBS Cholamandalam), infrastructure advisory business and sells financial products from its points of presence.

The company aggressively expanded its point of presence to become a pan-India player. From 227 points of presence in 2007-08, the companies expanded its distribution network to 837 points-of-presence, which would support its retail book growth. It will also allow it to leverage on fee income opportunities.

L&T Infrastructure Finance

L&T Infrastructure Finance is a diversified company, financing power, roads, telecom, oil and gas, ports and urban infrastructure. This is a relatively new player, incorporated in 2007. Yet, it has scaled its portfolio to Rs 7,186 crore, as of March 2011. The exposure is also pretty much diversified with power, roads and telecom accounting for 29 per cent, 17 per cent and 14 per cent of the total exposure.

The net interest margin (NIM) was 4.95 per cent for the year ended March 2011. The company last year got the Infrastructure Financing Status that will allow it to broad-base its borrowing profile and access lower cost of funds. The company also became a public financial institution in June 2011, which will allow it to borrow from insurance companies and pension funds. It will be able to use SARFAESI Act to recover secured assets. The company's net NPA ratio of this company was 0.5 per cent.The demand for infrastructure financing is high and is likely to remain so for quite sometime. The company is also into equity financing of infrastructure projects and also provides advisory services.

L&T Finance

L&T Finance was set up in 1994 as a SME financing company to fund its parent company's vendors and distributors. Today, it has evolved into a full-fledged NBFC that additionally provides equipment financing, tractor and commercial-vehicle financing, micro-financing and lending against shares for third parties. The company has also started used vehicle financing, which may offer high yields.

The size of the loan book, as of March 2011, was Rs 10,156 crore. This includes exposure of Rs 460 crore to the micro finance sector. L&T Finance's loan book is riskier than the infrastructure financing business as it involves lending to smaller and mid-sized businesses. However, the company only lends for income generating activities, thus mitigating the risk to some extent.

The NIM of L&T Finance was 7.9 per cent which may moderate, given the sharp rise in cost of funds and removal of priority lending sector status. The gross NPA ratio, as of March 2011, was 1.4 per cent. Once guidelines for MFI lending are finalised, the company may shift MFI activity to L&T Unnati (subsidiary of L&TFH). Then the MFI segment would get bank loans as part of priority lending status. L&TFH's MFI is scalable, given a strong backing from the promoter.

The company's corporate lending to vendors may sustain high growth, given its presence in supply-chain finance. Though most of the loans of L&T Finance is backed by assets, it is nevertheless exposed to cyclicality of the equipment and commercial vehicle segments.

L&TFH owns close to a 5 per cent stake in Federal Bank and City Union Bank. It also owns L&T Mutual Fund which has an asset base of Rs 5,200 crore as of June 2011.

Other risks and concerns

L&TFH would have to pay 5 per cent of the consolidated profits or 0.15 per cent of the assets which ever is lower for using Larsen and Toubro's trademark. The NBFC sector is passing through a regulatory uncertainty which may pose risk, going forward. Any slowdown in the economy would hit L&TFH.

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