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Provision reversal drives earnings beat

* Ujjivan SFB reported a strong beat on PAT, at Rs 2.9bn (vs our estimate of Rs1.9bn), mainly on continued negligible provision amid improving asset quality. The bank has guided for sustainable RoA at 2.25-2.5% going forward and credit cost of 1% for FY24.

* Overall credit growth accelerated to 27%YoY/12%QoQ due to continued growth from MFI/micro-individual loans as well as other retail loans. Disbursements were stronger at Rs48bn, mainly from MFI (78%); MFI share remains dominant at 71% of AUM and is, thus, a matter of concern, as the bank’s diversification strategy takes a back seat.

* Bank’s reverse merger is progressing well and has received NOC from the RBI; the bank expects the reverse merger to be completed by Sep-2023. We revise up our earnings for FY23E by 20%, while raising our estimates for FY25 by 5%, factoring-in a better growth trajectory and lower provisions.

* We believe FY23 is likely to be a bumper year for the bank, leading to 3.7% RoA/30% RoE owing to meaningful asset quality recovery and thus provision reversal, but is unlikely to be sustainable. We expect RoA/RoE to moderate to 2.2%/18% by FY25E, as provision cost normalizes. We continue to be concerned about the bank’s sub-par liability profile/higher MFI share. We retain HOLD on the stock with TP of Rs33/share and also on Ujjivan Financial Services (holdco) with TP of Rs312/share, applying 20% holdco discount.

* Growth accelerates, but takes a toll on margins: AUM saw strong growth at 33% YoY/5% QoQ to Rs219bn, while the net loan book grew 27% YoY/12% QoQ to Rs195.3bn. The strong growth was largely led by traction in MFI/micro-individual loan book and supported by retail (affordable housing). Disbursements were strong at Rs48bn, dominated by MFI at 78%; as a result, the share of MFI remains high at 71% of AUM, exposing the bank to asset-quality risk. Deposit growth was strong and surprisingly outpaced credit growth at 49% YoY/14% QoQ, which was due to faster growth in TDs; thus CASA ratio declined by 79bps to 26% and remains sub-par vs peers. Lower CASA and increasing cost pressure led to drop in margins by 40bps to 9.4%.

* Asset quality improves, leading to provision reversal: Fresh slippages were lower at Rs1.1bn/2.9% of loans, which coupled with healthy recoveries/w-offs led to sharp decline of 142bps QoQ reduction in GNPA ratio to 3.6%. The restructured book sharply declined to Rs3bn/1.5% from 2.7% in Q2. Overall collection efficiency remained robust, at an elevated level of 100%, which has reflected in the lower slippages as well as the decline in ‘portfolio at risk’ (PAR) at 4.9% vs 6.1% in Q2FY23 and 14.9% in Q3FY22.

* Outlook and Valuations: We believe FY23 is likely to be a bumper year for the bank, with 3.7% RoA/30% RoE due to meaningful asset-quality recovery and thus provision reversal, but is unlikely to be sustainable. We expect the RoA/RoE to moderate to 2.2%/18% by FY25E, as provision cost normalizes. We also remain concerned about the bank’s subpar liability profile/higher MFI share. We retain HOLD on the bank with TP of Rs33/share and also on Ujjivan Financial Services (holdco) with TP of Rs312/share, applying 20% holdco discount. Key risks: asset quality shock due to any macro-economic risk; poor liability profile weighing on margins.

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