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Earnings in line; digital transformation aiding momentum Raises its customer acquisitions and new loans guidance for FY23

* PAT grew 88% YoY to ~INR27.8b (in line) in 2QFY23. This healthy operational performance was driven by robust customer additions, new loan acquisitions, and strong velocity, aided by its omnichannel strategy and the digital ecosystem.

* NII grew 29% YoY to INR55.4b. Other operating income grew 31% YoY, driven by a healthy improvement in fee income and higher treasury and investment income.

* NIM (calculated) improved by ~3bp QoQ to ~13.3%. We expect NIM to remain stable in FY23, but compress by ~30bp in FY24 due to BAF’s limited ability to pass on the increase in borrowing costs against a large fixed-rate loan book.

* We model in an AUM/PAT CAGR of ~27%/40% and expect BAF to deliver a RoA/RoE of 4.6%/24% in FY24. We remain watchful of the various developments in BAF’s payment offerings, improvement in velocity from digital transformation, and foray into the Credit Card business, subject to approval from the RBI. We reiterate our Buy rating with a TP of INR8,310 (premised on 7.7x FY24E BVPS).

Customer acquisitions run-rate to improve from here on; expect AUM growth to be better than its long-term guidance of 23-24%

 * Total customer franchise rose 19% YoY to 62.9m. New loans booked grew 7% YoY to 6.8m. BAF raised its new customer acquisition guidance. It now expects 10-11m new customer acquisitions in FY23 (v/s its guidance of 9-  10m announced after its 1QFY23 earnings).

* Total AUM grew 31% YoY and ~7% QoQ to INR2.18t. Receivables from IPO financing stood at INR1.05b in Sep'22. Core AUM (adjusted for IPO financing) grew by ~INR142b in 2QFY23.

* Sequential AUM growth was driven by Urban B2C (+7%), Rural B2C (+7%), SME (+9%), LAS (+14%), and Commercial excluding LAS (+11%) and Mortgages (+8%).

* Urban/Rural B2B Sales Finance (-1%/-5% QoQ) acted as a drag in 2QFY23. It is important to note that the second quarter has historically been a seasonally weak quarter in Consumer Durable financing before the festive season sets in the third quarter of a fiscal. We expect 3QFY23 to be no different for BAF.

OPEX to remain elevated in FY23, led by geography expansions and investments in technology and human capital

*Operating expenses grew 24% YoY to INR25.1b. Given the deep investments being committed to its omnichannel strategy (geography expansion, app, and web platform) and payments, the management expects OPEX –to-NII ratio to remain elevated at 35-36% in FY23.

Strong risk management underpinning its healthy asset quality performance

* GS3/NS3 improved by 8bp/7bp QoQ to 1.17%/0.44%, with S3 PCR rising by ~2pp QoQ to ~62%. OTR book, classified under Stage 2, stood at INR3.4b (~16bp of AUM), why BAF carrying provisions of ~INR790m (~23%) on this book in 1HFY23. GS3/NS3 levels are the lowest-ever in the past six years.

* Credit costs in 2QFY23 stood at INR7.3b (~140bp annualized). The company will continue to hold a management overlay of INR10b in the near future and will subsequently release it, as it is seeing an improved credit performance.

Diversified liability franchise will be its moat in a rising rate environment

* Deposits constituted ~22% of consolidated borrowings in 1HFY23. BAF is on track to deliver its long-term goal of ~25% of consolidated borrowings from deposits in the medium term.

* Given the strong ALM, it shared that the impact of the recent interest rate hikes on cost of funds will remain gradual, which will aid margin.

Highlights from the management commentary

 *The management guided at a quarterly run-rate of INR7.25-8b in credit costs (1.35-1.45% of average assets in FY23).

* It doesn’t foresee any change in the growth outlook of BHFL, given RBI’s mandate for it to list within three years of it being recognized as a NBFC-UL.

* The company would have lost some market-share in the Consumer Durable Financing segment and in the OEM subvention pool due to a higher number of lenders in stores. Going forward, it anticipates that the dependence on the B2B Sales Finance segment for customer acquisition will reduce, if it is able to execute its digital transformation program. 

Valuation and view

 * Customer acquisitions and the new loan trajectory have been strong. The momentum will only get stronger from here on, with the digital ecosystem – app, web platform and the full-stack payment offerings – in place.

* We expect BAF to deliver a healthy AUM CAGR of ~28% over FY22-24. We see a compression in NIM in FY24, given as the levers on borrowing costs have largely played out and it has limited ability to pass on the higher cost of funds on a large fixed-rate book.

* We raise our FY23/FY24 PAT by ~3% each to factor in higher fee income and lower credit costs. We estimate BAF to deliver a RoA/RoE of 4.6%/24% over the medium term. We reiterate our Buy rating with a TP of INR8,310 (premised on 7.7x FY24E BVPS).

* The key factors to watch out for in FY23-24 are: a) evolution of its payments landscape and the traction therein; b) velocity on the consumer app and the adoption of the envisaged web platform; c) potential foray into the Credit Card business from its own Balance Sheet (subject to RBI approval); and d) the NIM trajectory.

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