The hopes of a banking licence, now that Parliament has cleared the banking amendment law, have boosted the shares of non-banking financial companies, but L&T Finance Holdings Ltd more than most others. The company’s shares have risen 20% so far this month, compared with 11.57% for Shriram Transport Finance Co. Ltd and 9.33% for Mahindra and Mahindra Financial Services Ltd.
Investors rightly view L&T Finance as one of the frontrunners for a banking licence, given that it is not a promoter-led entity and the shareholding of its parent is widely diffused. But, does that mean its valuations are sustainable?
The company is trading at 25.5 times its 12-month estimated earnings, at a premium to rivals such as Shriram, Mahindra Financial and Bajaj Finance Ltd. Not only that, the current share price is 2.89 times its 12-month book value.
As Espirito Santo Securities pointed out in a recent note, that is a premium to Yes Bank Ltd (and indeed, all other banks barring HDFC Bank Ltd, Kotak Mahindra Bank Ltd and IndusInd Bank Ltd), which has a similar market capitalization, but a far bigger loan book. Yes Bank has a loan book of around Rs.42,000 crore compared with Rs.28,000 crore for L&T Finance. The former has a gross non-performing asset ratio of 0.2% compared with 1.56% for L&T Finance.
Not only that, the path to getting a bank licence is long and thorny. Anyway, given its legendary caution, analysts expect the central bank to hand these out only after a year or so. In the meantime, the company has to continue growing its loan book strongly, not an easy task given that the investment cycle is not picking up.
Secondly, a banking licence doesn’t mean that profits are for the taking, as the Espirito note said. A bank’s cost profiles are very different from those of a non-banking finance company, given other requirements such as priority sector targets. Moreover, as the eight-year-old Yes Bank can testify, building a low-cost current account and savings account (casa) deposit base will take a very long time. New banks also have to build a branch network, a quarter of which has to be in unbanked areas, which will blow out the cost to income ratio in the initial years.
In sum, while getting a banking licence can be a positive, it isn’t easy to justify L&T Finance’s valuation, especially at a time when the pace of profit growth is faltering and disbursements declined from a year ago.