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Buy Ujjivan Small Finance Bank Ltd For Target Rs.40

Strong all-round performance

A substantial beat with impressive core internals

Ujjivan delivered a 32%/56% beat on our PPOP/PAT expectations driven by higher other income (strong core fee growth + bad debts recovery), credit cost reversal (continued robust collections and NPL recoveries) and lower opex (collection-related costs normalization). Notably, there were no one-offs or significantly chunky benefits in this quarter versus the preceding quarter.

Other significant aspects of USFB’s Q2 FY23 performance were 1) substantial loan growth (8% qoq/44% yoy) underpinned by Micro Banking segment (with normalizing ATS and customer addition), 2) strong deposits growth (11% qoq/45% yoy) on sustained CASA traction (improving balances) and accelerated Retail TD growth (improving renewals) and 3) marginal NIM expansion on increase in Micro Banking yield (50 bps rate hike from Sept + negative net slippage) and limited increase in CoF (lesser incremental reliance on Bulk TDs) and 4) further shrinkage of the stress pool (SMA + Restructured + NPLs) through collections (PAR 0 reduction from 7.9% to 6.1%).

Guidance lifted on many key performance parameters

Encouraged by another strong performance in Q2 FY23 and extant growth and collections/recoveries trends, the management has either maintained or lifted its guidance/expectations on key performance parameters for FY23 viz. 1) Loan growth expected to be 30%, 2) Deposits expected to grow faster than loans with granularization continuing, 3) NIM estimated to be around 9.5% for the year (9.7% in H1) with lending rate hike taken in Micro Banking effective September, 4) Cost/Income ratio to be comfortably below 60% for the year notwithstanding acceleration of franchise investments for deposits mobilization (distribution, branding, tech/digital, etc.), 5) Credit cost to be contained below 1% (largely ageing provisions in H2 - marginal net slippages) and 6) profits in H2 estimated to be similar to H1 (Rs4.97bn) and thus RoA for the year to be significantly better than earlier guidance of 2.3%.

Significant upgrades in estimates; sustainable 18-20% RoE in FY24

The main highlight of USFB’s performance over the past few quarters has been stronger-than-industry collections/recoveries from restructured, NPL and written-off pools. This has allowed the bank to capture market and deliver stronger growth. Muchbetter-than-expected trajectory of growth, non-interest income, cost metric and credit cost in H1 FY23 and management’s strong commentary about the future normalized outcomes has led us to revise our earnings estimates by 20-27% for FY23/24. While FY23 will be an exceptionally profitable year due to lower-than-usual credit cost and higher-than-usual bad debts recovery, we estimate the bank to deliver 18-20% RoE even under normalized circumstances. Expect stock to re-rate further; we maintain BUY with revised 12m PT of Rs40. Despite the recent run-up, the valuation is undemanding on the revised estimates (6.4x P/E and 1.2x P/ABV on FY24E).

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