Buy LIC Housing Finance, target Rs 550: Motilal Oswal Securities

Motilal Oswal Securities has a buy call on LIC Housing Finance with a target price of Rs 550.

The current market price of LIC Housing Finance is Rs 445.95.

Time period given by the brokerage is one year when LIC Housing Finance price can reach the defined target.


Investment rationale by Motilal Oswal Securities:
Post the 4QFY17 results, we had downgraded LIC Housing Finance (LICHF) to Neutral citing concerns on rising share of non-core home loans, modest core home loan growth vis-à-vis peers, risk to spreads and rich valuations.

Over the past 5-6 quarters, we believe our thesis has largely played out. Core home loan growth has remained nearly 10 per cent YoY, while the share of non-core products increased from 16 per cent in FY17 to 21 per cent in 1QFY19. Calculated spreads declined from a medium-term high of 1.95 per cent in 4QFY17 to 1.31 per cent in 1QFY19 (close to historical low of 1.1 per cent). Hence, valuations have corrected from 2.6x PB (1-year forward) then, to 1.3x PB now.

In our view, the key reason for such a sharp compression in spreads is: (a) On 1 January 2017, SBI had cut its MCLR by 90bp prompting all other HFCs to also cut their lending rates immediately by a similar magnitude. Given that LICHF was and is migrating towards floating rate loans (83 per cent share currently v/s 56 per cent two years back), this had an immediate impact on yields. Yields have declined nearly 100bp since 1-January 2017 to 9.6 per cent now, and (b) Re-pricing of liabilities happens much slower in LICHF as compared to its peers since only nearly 20-25 per cent of liabilities mature annually as compared to 33 per cent for PNBHF, 37 per cent for IHFL and 50 per cent+ for HDFC. Hence, LICHF was not able to benefit from the falling interest rate scenario during FY16-17 as much as its peers.

We believe the scenario is reversing for LICHF. Our thesis is largely based on spreads. We have closely studied the liability structure of LICHF. Our analysis shows that LICHF has Rs 216b of non-convertible debentures (NCDs) maturing in FY19 and Rs 222b of NCDs maturing in FY20. These NCDs bear a relatively high weighted average cost of 8.46 per cent and 8.32 per cent, respectively. Our calculation shows that even if these NCDs are refinanced at 9.0 per cent, the weighted average cost of funds would increase 15-20bp each year (we have baked in 45bp CoF increase over FY18-20E). On the other hand, LICHF has taken four yield hikes cumulating to 60bp across the entire loan book over the past six months. This will more than offset the increase in cost of funds over the next two years.

Yet, to be conservative, we model spreads to decline from 1.35 per cent in FY18 to 1.22 per cent in FY19 and remain largely stable thereafter. The average spread of the past five years is 1.4 per cent and of the past 10 years is 1.6 per cent.

Our bear-case sensitivity (Exhibit 3) reveals that even if maturing NCDs are refinanced at 9.5 per cent, impact on FY19/20E PBT would be only 3 per cent.

View of the brokerage on the company: Given the nearly 25 per cent share price decline over the past six months, we believe the street is factoring in sustained spread compression over the medium-to-long term. With its strong parentage and AAA-credit rating since 2002, we believe LICHF will be much better placed than peers in such times of tight liquidity. In addition, balance transfer pressure could ease as peers are facing liquidity pressure. Key risks to our earnings stem from asset quality pressure in the corporate book and negative surprises from Ind-AS accounting. Valuations at 1.3x FY20E PB are close to decadal lows and risk-reward is favorable, in our view. We expect re-rating driven by stable earnings growth over the next 4-8 quarters. Upgrade to Buy with a target price of Rs 550 (1.6x FY20E BVPS).