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Strong earnings beat, but higher share of MFI remains a concern

* Ujjivan SFB reported a strong PAT beat at Rs2.94bn (vs Emkay est at Rs0.98bn), mainly due to higher other income and provision reversal. Bank expects the RoA trajectory to remain sturdy in FY23 led by better growth, margins and continued moderation in LLP given the current stock of NPAs being largely covered.

* Overall AUM/credit growth accelerated to 44%/29% YoY, largely on strong traction in MFI, SME and housing segments. Share of MFI loans inched up to 69%, which is worrying as other banks look to diversify away from MFI. Bank has guided for ~30% growth in FY23E, with back-book stress easing and given its strong capital buffer post the recent QIP.

* The bank has successfully completed QIP, thus paving the way for SEBI approval; it is in the process of gaining residual regulatory/NCLT approval, to complete the merger process over the next 12 months. Factoring-in the strong growth guidance, margin and asset quality improvement, we raise our earnings estimates for FY23-25. We expect the bank’s RoA/RoE to shoot up to 3.2%/27%, and normalizing thereafter to 2.2%/19%.

* Building-in the earning upgrades and higher P/ABV at 1.2x (v/s 0.9x earlier) on Sep-24E ABV, we upgrade our TP to Rs30/share (from Rs18). However, we retain HOLD on the stock, as we believe that the bank will remain prone to asset quality shocks given its higher share of MFI portfolio and still sub-par liability profile. Management stability, too, remains a long-term issue for the bank. We retain HOLD on Ujjivan Financial Services (holdco), with a revised TP of Rs284/share (from Rs170), applying a 20% holdco discount.

* What we liked: Accelerating pace of business growth and continued sharp improvement in asset quality, leading to provision reversal, What we did not like: Increase in share of MFI loans to 66% of loans, though Bank is otherwise prone to asset quality risks and moderation in CASA ratio

* Strong growth, better yields support margins: Ujjivan SFB reported strong AUM growth, at 44% YoY/8% QoQ, while net credit growth stood at 29% YoY/6% QoQ. This was mainly led by the MFI, SME and affordable-housing segments. However, increase in share of the MFI book to 69% of loans exposes the bank to asset quality risk and is, thus, concerning. Deposits growth, too, was robust at 45% YoY/11% QoQ, but CASA ratio declined by 100bps to 27% and remains sub-par vs peers. NIM improved by 20bps to 9.8% due to better growth/loan yields, but Mgmt expects medium-term NIM of 9.5%.

* Lower fresh NPA formation drives continued improvement in asset quality: Fresh slippages moderated to Rs0.75bn/2.2% of loans, which, coupled with better recoveries/upgrades, led to a sharp 150bps reduction in GNPA ratio to 5.1% of loans. Overall restructured pool, too, reduced, to Rs4.7bn/2.7% of loans vs 4.0% in Q1. Overall improved collection efficiency reflects in the lower slippages as well as in the decline in the ‘portfolio at risk’ (PAR) to 6.1% vs 7.9% in Q1FY23 and 9.6% in Q4FY22.

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