Initiating Coverage - STRONG BUY
Current Price: LKR 2.1 Fair Value: LKR 3.7
“Gearing up for the Future”
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LOFC has the second largest individual asset base in the Non-Banking Financial Institution (NBIF) sector in Sri Lanka, and is expected to grow at an impressive CAGR of c.25% in earnings during the period FY16-FY19E, to reach LKR 3.5Bn in FY19E. The company is expected to grow its earnings mainly through an increase in lending at a CAGR of c.15% to LKR 145.2Bn in FY19E along with improved Net Interest Margins (NIMs) of c.10.0% during the same period. FC Research expects LOFC to provide a total return of 76% at LKR 3.7. STRONG BUY
Change in Lending Portfolio mix to counter asset liability mismatch: In response to the past rising interest rate environment, a shift in the focus of the loan portfolio from long term products, leasing and loans, towards a short term product, factoring. This would help match the predominantly short term liabilities with the more long term asset base, and thereby reduce the exposure to NIM deterioration caused by the higher interest rates.
NIMs to improve with interest rate decline: NIMs expected to improve from c.8.5% in FY17E to c.8.7% and c.10.0% in FY18E and FY19E respectively. This is due to the time lag between the borrowings and lending re-pricing, where borrowing rates would decline at a faster rate than the lending rates in a declining interest rate environment which would in turn expand NIMs.
Reduced NPLs with improvements in the secondary market for vehicles: Reduction in NPLs with improvements in the second hand market for vehicles will have indirect positive effect on earnings through reduction in the loan loss provisions.
Investment Risk: Operating in the finance sector, LOFC is exposed to credit, market and regulatory risks.
LOFC to provide a total return of 76%: FC Research expect LOFC to achieve a fair value of LKR 3.7 providing a total return of 76% (Capital Gains 76%, Dividend yield 0%) over a 12-month period. [RI based LKR 3.5, Justified PBV based LKR 3.8, PER based LKR 5.0 and illiquidity discount of 10%].
Disclosure on Shareholding:
First Capital Group and its affiliates do not hold shares in LOFC. Neither First Capital Group nor its affiliates have traded in the shares in the three trading days prior to this document, and will not trade in the shares for three trading days following the issue of this document.
Discount for liquidity:
The fair value of LOFC has been adjusted 10% downwards to reflect the lower trading volumes of the share compared to the average trading volume of the market.
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