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Core earnings weak; PAT miss despite high assignment income

No improvement in asset quality came across as a surprise

* AAVAS Financiers (AAVAS)’s 2QFY23 PAT grew 16% YoY to ~INR1.1b (5% miss). Elevated opex with cost-income ratio at ~45% (PY: 41%) led to the earnings miss despite benign credit costs of INR16m (~5bp annualized).

* NII grew 15% YoY to INR1.88b (in line). Other income rose 42% YoY driven primarily by high upfront assignment income of INR494m (because of higher quantum of direct assignments in 2QFY23).

* Opex (7% higher than estimated) grew 33% YoY in 2QFY23 due to spending on digital transformation, investments in manpower and leadership team and opening of newer branches. The company guided that cost efficiencies and operating leverages will kick in from FY24 onwards leading to a sustainable improvement in cost-asset ratios thereafter.

* No improvement (or very marginal deterioration) in asset quality came across as a surprise with GS3/NS3 at 1.1%/0.8%, respectively.

* We model an AUM and PAT CAGR of 24% each over FY22-24E for an RoA/ RoE of 3.7%/16% in FY24, respectively. Valuations capture its growth trajectory and superior asset quality franchise. Before turning constructive, we would monitor the impact of rising interest rates on spreads and NIM and on delinquencies, if there is a notable rise in EMI for customers. We maintain our Sell rating with a TP of INR1,820 (based on 3.8x FY24E BVPS).

Disbursements gathering momentum; AUM rises 24% YoY

* AAVAS’ AUM was up 24% YoY/5.5% QoQ to ~INR125.4b as of 1HFY23. The annualized run-off in the loan book declined to a normalized run-rate of ~17% (v/s 19% in the previous quarter). Management shared that BT-OUT has declined to 0.5% per month (v/s earlier run-rate of 0.6% per month).

* Disbursements were healthy and grew 27% YoY to ~INR11.5b.

Marginal deterioration in asset quality; sustained improvement in 1+ dpd

* No improvement (or very marginal deterioration) in asset quality came across as a disappointment with GS3/NS3 at 1.1%/0.8%, respectively.

* 1+ DPD improved to 4.5% (from 4.7% in Jun'22). Effective Apr'22, repossessed properties with total quantum of INR120m were classified as NPA (and not as assets held for sale).

Spreads and NIM decline QoQ

* Though AAVAS reported improvement in yields and spreads, our calculated numbers suggest that there has been a ~15bp QoQ decline in the core lending spreads. This even led to a ~10bp QoQ compression in NIM.

* Reported spreads in 2QFY23 improved ~5bp sequentially to ~5.86%, while 1HFY23 reported NIM (including fee & other income) improved ~50bp QoQ.

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