Why You Should Accumulate LIC Housing Finance Stock Now

One’s loss is another’s gain. This is the investment logic behind LIC Housing Finance Ltd (LICHFL) stock. The mortgage industry, which until 2019 was quite crowded, now finds itself with a handful of players. The merger of HDFC Limited (the market leader) with HDFC Bank will leave a bigger void for investors.

LICHFL trading at a low four-year valuation of 0.9 times the estimated pound for FY23 could close the gap to some extent. Asset quality issues addressed by management and a renewed focus on retail lending are prompting investors to maintain their position in LICHFL shares. Those with some risk appetite (given the possibility of delayed improvement in loan growth) may consider hoarding the stock at current levels.

Macro benefits

DHL exited the housing finance space in 2019. In the same year, Indiabulls Housing, then the third largest mortgage lender, changed its growth strategy to reduce it in assets or slow balance sheet growth. A year later, PNB Housing, the fifth largest player, was hit hard by the pandemic and had to slow down its business due to its lack of capital. Meanwhile, the housing finance market has polarized into two fragments – the big players who remain competitors to banks and those exclusively in the affordable housing market. While the latter segment is well represented by stocks such as Aadhar Housing, Home First, Aptus and Repco, the former segment is pretty much left with just two big players – HDFC Limited and LICHFL. This is expected to decline further, leaving LICHFL with an opportunity in terms of volume and scale of market potential that it has not taken advantage of much in the past.

This defines a favorable investment case for the stock. The question is whether LICHFL is well placed to seize this opportunity.

Errors corrected: The underperformance of LICHFL stock in 2020 was largely due to the possibility of a merger with IDBI Bank in accordance with LIC’s (its parent company) shareholding agreement for IDBI Bank. But that option has recently been ruled out as LIC is trying to sell its stake in the bank.

As of FY21, the lender was not spared from asset quality issues. Gross non-performing assets increased 46% to 4.1% in FY21 and peaked at 5.9% in the first quarter of FY22. From these levels, the March quarter in FY22 (Q4) saw a significant respite to 4.6%, reiterating management’s commitment to improving asset quality. What inspires confidence is that the improvement in the fourth quarter did not occur due to the denominator effect (loan growth). If anything, loan growth for the year 22 to 8% year-on-year is rather slow compared to industry growth of over 12%. While the normally slow growth rate is viewed negatively, for LICHFL it is somewhat acceptable given management’s promise to remain focused on the retail side rather than short-term wholesale lending.

In fact, it’s the unfavorable loan mix that has cost the company dearly during the pandemic.

Composition of loans

LICHFL’s strength is its focus on retail customers and that too on a high proportion of the employee base. This mix is ​​unique to the company, which even players such as HDFC Limited and PNB Housing do not have. The rally between 2015 and 2019 was driven by this advantageous positioning.

But meanwhile, the lender has increased non-retail lending to support growth. The share of wholesale loans rose from 5% to over 7%, which subsequently triggered the mess of bad loans. Today, the base is turning back in favor of retail lending, with its share rising 400 basis points from 77% in FY20 to 81% in FY22.

Loan disbursements to the wholesale segment moderated in FY22 at ₹1,300 crore from ₹2,500 crore and ₹3,100 crore in FY20 and FY21 respectively. However, the product line leaning towards retail lending is not captured by the market. Sustained performance on this setting might help. Additionally, with a 5% share of the wholesale portfolio, LICHFL’s exposure to non-commercial loans is the lowest (12% and above for peers), which should also help the stock revalue.

However, with the renewed focus on retail lending, overall loan growth could remain weak given current inflationary conditions. Going forward, loan growth of 12-14% (seen before the pandemic) may be a more realistic expectation than the 15%+ growth that peers are anticipating.

Profitability

Unlike its peers which are at 3% plus net interest margin (NIM), LICHFL’s profitability has always been below 3%. Since it largely caters to the salaried segment which tends to be rate sensitive but has low risk of default, LICHFL home loan rates are among the lowest offered by non-banks, and competitive even HDFC Limited or PNB Housing.

In addition, given the reduction in the low benefit cost of the fund, LICHFL may need to absorb some of the rate hike to ensure growth remains buoyant. In fact, after the May 4 rate hike, LICHFL raised its lending rate by 30 basis points absorbing 10 basis points of its yields. Therefore, the NIM could remain stagnant at levels of 2.5-2.6% (annualized) in the near term.

Ratings

At 0.9 times the estimated pound for FY23, valuations are capturing downside risks. HDFC Limited’s (basic housing book) standalone premium to LICHFL, which was historically above 50%, has decreased. From 1.6 times the one-year term book for HDFC’s mortgage business through December 2021, the number has been reduced to 1.2 times. Additionally, LICHFL’s premium to PNB Housing (after the June 2021 correction) has increased, with the latter trading at 0.6 times the estimated pound for FY23. Therefore, in the long term, LICHFL stock may not become a value trap.

Published on

June 11, 2022