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Strong business momentum to continue.

Ujjivan Small Finance Bank Ltd., a wholly owned subsidiary of Ujjivan Financial Services Ltd. (USFL), serves over 76 lakh customers through 661 branches. USFL is the 3rd largest SFB with a loan book size of Rs.25,326cr and a deposit base of Rs.26,660cr.

* Advance growth is expected to remain strong at 25%, led by both microfinance and non-MF book with strong customer addition and brand building strategies.

* Considering strong loan growth, an improving cost to income ratio and lower credit costs, USFL is expected to record an ROE of 25% in FY24 and 23% in FY25, well above the management guidance.

* The proposed reverse merger with the parent company is expected to be completed within 2024.

* Asset quality continues to witness improvement, with GNPA/NNPA declining to 2.40%%/0.06%, respectively.

* Considering the strong business performance, we upgrade our rating to BUY based on 1.8x FY25E Adj.BVPS with a target price of Rs. 62.

Loan growth to remain strong led by MF portfolio

USFL continued to show robust loan growth supported by strong disbursement and customer addition. The bank has adopted strategies to increase brand visibility along with new branch additions and aims to build a retail-focused franchise. Advance growth of 30% YoY was supported by a microfinance portfolio that grew by 37%. Strong traction was seen in non-MF books too. As of Q1FY23, MF books constitute 72% of total AUM. With the growth momentum expected to continue, management has shown confidence in achieving 25% growth during FY24. We expect the loan book to grow at a CAGR of 25% over FY23–25. Management also aims to increase the mix of secured loans to 40% in the long run. On the liability side, the bank's total deposit increased by 45% YoY to Rs. 26,660 cr, with retail deposits increasing by 71% year on year to Rs. 10,970 cr. CASA continued to witness a sequential decline as funds moved to term deposits. The bank aims for deposit growth of 30% for FY24.

Enhanced profitability aided by healthy credit growth & lower cost

During Q1, Net Interest Income increased 36% YoY and 6% sequentially supported by strong loan growth along with a 10bps sequential increase in margins to 9.2%. The reported yield of the bank improved 20bps QoQ to 19.1%, with the MFI yield improving 20bps to 21.8%. With rising interest rates, the reported cost of funds witnessed a QoQ increase of 30bps to 7.2%. Though more cost pressure is expected from the repricing book, management is confident in maintaining NIM above 9%. The cost-to income ratio improved to 53% as new branches moved towards maturity. The pre-provision profit of the bank grew 52% YoY and 12% sequentially to Rs.458cr. The bank has reported a strong PAT of Rs.324cr compared to Rs.203cr in Q1FY23. With improving asset quality and high PCR, the management expects the credit cost to be below 1% for FY24, though higher provisioning is expected in H2. The ROA of the bank stands at 3.8% and the ROE at 29.8%. Management aims to keep ROE above 22% for FY24.

Improving asset quality with healthy provision

USFL has been proactive in improving its asset quality with lower incremental stress and higher recoveries. Though Q1 saw a sequential increase in slippages, it remained within the comfort zone. The collection efficiency of the bank stood at 102% in June. A significant reduction is seen in the stressed book as the GNPA improved 20bps sequentially to 2.4%. Higher provision coverage will help the bank keep credit costs under control. The NNPA of the bank stood at 0.06%.

Valuations

UFSL has shown strong business momentum with improved asset quality and strong loan growth. The bank is moving ahead of their guidance by achieving 25% loan growth. Though cost pressure is expected to trim the margins, management is confident in maintaining NIM in a healthy range above 9%. With high levels of provisioning, the credit cost is expected to remain low. Considering the improvements in business fundamentals, we upgrade our rating to Buy, valuing the company at 1.8x FY25 Adj.BVPS with a target price of Rs.62.

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