MOSL: LIC HOUSING FINANCE (Upgrade to Buy)-Parentage and access to debt capital key moats

LIC Housing Finance: Parentage and access to debt capital key moats; Minimal downside risks to earnings; Valuations attractive at 1.3x FY20 PB

(LICHF IN, Mkt Cap USD2.8b, CMP INR431, TP INR550, 28% Upside, Upgrade to Buy)

• 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 ~10% YoY, while the share of non-core products increased from 16% in FY17 to 21% in 1QFY19. Calculated spreads declined from a medium-term high of 1.95% in 4QFY17 to 1.31% in 1QFY19 (close to historical low of 1.1%). 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% share currently v/s 56% two years back), this had an immediate impact on yields. Yields have declined ~100bp since 1-January 2017 to 9.6% now, and (b) Re-pricing of liabilities happens much slower in LICHF as compared to its peers since only ~20-25% of liabilities mature annually as compared to 33% for PNBHF, 37% for IHFL and 50%+ 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 INR216b of non-convertible debentures (NCDs) maturing in FY19 and INR222b of NCDs maturing in FY20. These NCDs bear a relatively high weighted average cost of 8.46% and 8.32%, respectively. Our calculation shows that even if these NCDs are refinanced at 9.0%, 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.