Project Cyclops And Nostradamus Launch Will Expand Diverse Lending

Key Takeaways

• Expansion of AI/ML initiatives like Project Cyclops is set to enhance credit efficiency and profitability by reducing credit costs and boosting margins.
  
• Strategic market diversification and acquisitions aim to drive revenue growth through expanded secured lending and improved geographic reach.
  
• Challenging conditions in microfinance, weather risks, tariffs, rising credit costs, and new regulations threaten L&T Finance's revenue and net margins stability.

Catalysts

A non-banking financial company, engages in the provision of various financial products and services in India.

• The expansion of Project Cyclops, an AI/ML-based credit writing engine, to various lending segments, including the 2-wheeler business and upcoming implementations in personal loans and SME finance, is expected to reduce credit costs significantly. This improvement in asset quality will potentially enhance net margins by lowering risk and boosting overall profitability.
  
• The anticipated integration and scaling of the gold loan business, following the acquisition from Paul Merchants Finance, is expected to add a new high-yield secured revenue line. This could drive growth in revenue and support earnings by expanding the retail business franchise.
  
• The continued focus on diversifying into under-leveraged markets, such as expanding the microfinance geographical footprint in regions like Assam, Western UP, and Rajasthan, aims to support a balanced growth in disbursements. This strategy seeks to boost revenues through increased market penetration while maintaining sound asset quality.
  
• Strategic technological projects, such as the pending launch of Project Nostradamus, an AI-driven real-time portfolio and credit risk management engine, are set to operationalize in FY’26. These initiatives aim to improve operational efficiencies, manage risks better, and potentially increase net margins by reducing credit administration costs.
  
• Enhancing brand visibility and customer acquisition through marketing partnerships and new distribution networks, like those targeting specific SME audiences and expansion into mobile and digital platforms, is planned to drive revenue growth by attracting a more extensive customer base across various lending segments.

L&T Finance Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming L&T Finance's revenue will grow by 25.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 34.1% today to 30.4% in 3 years time.
• Analysts expect earnings to reach ₹47.0 billion (and earnings per share of ₹18.72) by about May 2028, up from ₹26.4 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹52.5 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.4x on those 2028 earnings, down from 15.4x today. This future PE is lower than the current PE for the IN Diversified Financial industry at 26.2x.
• Analysts expect the number of shares outstanding to grow by 1.14% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.09%, as per the Simply Wall St company report.

L&T Finance Future Earnings Per Share Growth

Risks

• The operating environment in the microfinance sector remained challenging, with state-specific events like the Karnataka Ordinance impacting collection efficiencies, posing risks to revenue and net margins.
  
• The potential impact of adverse weather shocks, such as heat waves and altered rainfall patterns, adds uncertainty to agricultural output, which could affect earnings in the rural finance segment.
  
• Trade tariff-related measures have exacerbated uncertainties in the global market, posing new headwinds for growth and inflation, which can negatively impact revenue.
  
• Increasing credit costs in unsecured consumer lending, particularly in the microfinance sector due to macro events, could lead to higher loan loss provisions, affecting net margins.
  
• The implementation of new regulations and ordinances related to unauthorized lending in regions like Tamil Nadu could disrupt the microfinance business operations, impacting revenue stability.

Valuation

• The analysts have a consensus price target of ₹177.737 for L&T Finance based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹220.0, and the most bearish reporting a price target of just ₹105.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹154.7 billion, earnings will come to ₹47.0 billion, and it would be trading on a PE ratio of 14.4x, assuming you use a discount rate of 14.1%.
  
• Given the current share price of ₹164.17, the analyst price target of ₹177.74 is 7.6% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.