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Playing for the long innings – Earnings growth to accelerate from FY25; Upgrade to BUY

* AUBANK delivered an impressive 54%/34% CAGR in deposits/loans over FY18-23. It has evolved as a strong franchise not just in the SFB segment but in the overall mid-cap banking space.

* Scale-up of new products, widening geographical reach, aggressive investments in technology and thrust on physical expansion should support long-term growth. We estimate the bank to maintain industry-leading loan growth at ~28% CAGR over FY23-25E.

* While near-term pressure on margins will remain an overhang on stock performance, we estimate earnings growth to accelerate from FY25 onward to 35% YoY after 22% YoY growth in FY24, leading to RoA/RoE of 1.9%/17%.

* AUBANK’s stock has corrected ~12% in the past few months and is now trading at 3.2x FY25E BV vs. 3-year/5-year average valuations of 3.8x/4.0x P/BV.

* We thus upgrade our rating to BUY with a TP of INR825 (based on unchanged 3.7x FY25E BV).

Deposit mobilization imperative to support growth

AUBANK has progressed well in building a granular liability franchise. The bank reported a 54% CAGR in total deposits over FY18-23, led by CASA deposits, which saw a 66% CAGR over the same period. The CASA mix, thus, improved from 23% in FY21 to 38.4% in FY23. The mix of retail term deposits also improved to 51% in 1QFY24. However, given the sharp rise in interest rates and rising competition for deposits, maintaining a healthy growth rate in liabilities is imperative to support robust loan growth.

* AUBANK has significantly deployed additional liquidity on the balance sheet as LCR ratio declined from 151% in 4QFY23 to 119% as on 1QFY24.

* The bank’s CD ratio has increased to ~91% vs. ~84% in 4QFY23. We thus expect the bank to focus on raising deposits and we estimate a 26% deposit CAGR over FY23-25.

Loan growth steady; estimate 28% CAGR over FY23-25

*  AUBNAK reported 29% loan growth in 1QFY24 vs. a 5-year CAGR of 48% over FY17-22. Retail loan mix continues to dominate with a share of ~79%. The bank is focusing on diversifying the loan book, with Home Loans seeing strong traction. The wholesale book has also grown at a healthy pace. The management focuses on strengthening the key business lines of Vehicle Loans and MSME and scaling up new segments, such as Housing Loans, Gold Loans, Credit Cards, Consumer Durable Financing, etc. Strong investments in the business and widening geographical reach will continue to aid business growth and further reduce geographical concentration. We thus estimate loan growth to remain steady at ~28% CAGR over FY23-25.

Elevated funding cost to remain a near-term drag

The fixed-rate nature of loan book (66% of loans being fixed rate) has affected AUBANK’s ability to pass on rising interest rates to its borrowers. We note that the yield on AUM has been stagnant at ~13.4% for the past 5-6 quarters. Besides, the yield on fresh disbursements has also been largely flat for the past many quarters and only increased by 29bp in 1QFY24. Further, the cost of funds has seen a constant rise as it increased by ~90bp over the past one year (up 31bp in 1QFY24). We believe that liabilities will continue to re-price at a faster pace, outpacing the lending yields. and thus further impacting spreads. We estimate the exit cost of funds to rise by another 50bp to 7.1% from 6.6% in 1QFY24.

NIMs contracted 38bp in 1QFY24; bank has guided for NIMs of ~5.5%-5.7%

AUBANK’s margins have moderated by 38bp to 5.72% in 1QFY24 from 6.1% in 4QFY23.The bank has indicated that an uptick in funding costs and flat trends in disbursement yields have impacted margins. As AUBANK largely has a fixed-rate book forming ~66% of total loans, we expect only a gradual recovery in yields. Given rising competition in the key lending segments both from banks and NBFCs, it has been difficult to pass on the entire rate hike to borrowers. The management expects NIMs to sustain at ~5.5%-5.7% in FY24. In the recent policy announcement, the RBI increased CRR on incremental NDTL between 19th May’23 to 28th Jul’23 by 10%; however, we note that as AUBANK focused mainly on liquidity deployment during the quarter and deposit growth was flat, it is likely to see minimal impact of this move by the RBI. We thus estimate a 23% CAGR in NII over FY23-25.

Business investments to continue; aiming to build a sustainable franchise

The bank has been constantly investing in the business by adding branches, hiring employees and building digital infrastructure and capabilities, which have kept operating expenses high. As a result, its C/I ratio increased to 65% in 1QFY24 (62- 65% over the past 4 quarters). The bank has added 44 new branches and invested INR1.6b in technological advancements in the current year. The bank has indicated that it will continue to make investments in its business and technological capabilities and further plans to add 50+ branches and touch-points in FY24. We thus expect the C/I ratio to remain elevated at ~63% in FY24.

Asset quality to recover after a seasonal 1Q blip

AUBANK’s slippage run rate stood at ~2.4% in 1QFY24, a seasonally weak quarter. This, coupled with healthy recoveries and upgrades, resulted in a slight deterioration in asset quality ratios. GNPA/NNPA ratios deteriorated by 10bp/13bp QoQ to 1.76%/0.55%, while PCR declined to 69%. The total restructured book moderated to INR6.3b (~1.0% of total loans) in 1QFY24, on which the bank carries provisions of INR1.0b. Going forward, we expect asset quality to recover and we estimate the credit cost to remain in control at 25-30bp over FY24-25.

Earnings growth to accelerate from FY25 onward; upgrade to Buy

AUBANK has evolved as a strong franchise not just in SFBs but in overall mid-cap banking space, and given strong investments in the business, improving geographical and product diversity and a track record of execution, we believe the stock will be a compounder in the long term. AUBANK’s stock has corrected by ~12% in recent months due to concerns over margin and high opex, which also led to a moderation in return ratios. While near-term pressure on margins will remain an overhang on the stock’s performance, we estimate earnings growth to accelerate from FY25 onward to 35% YoY after 22% YoY growth in FY24, leading to RoA/RoE of 1.9%/17%. The stock is now trading at 3.2x FY25E BV vs. 3-year/5-year average valuations of 3.8x/4.0x P/BV. We thus upgrade our rating to BUY with a TP of INR825 (based on unchanged 3.7x FY25E BV).

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