Buy AU Small Finance Bank Ltd For Target Rs. 900 by Axis Securities Ltd
Stress to Ease from H2FY26 Onwards; Confident of 1.8% RoA in FY27!
Est. Vs. Actual for Q1FY26: NII – MISS; PPOP – BEAT; PAT – BEAT
Changes in Estimates post Q1FY26
FY26E/FY27E (in %): NII -4.8/-4.9; PPOP +0.2/+1.6; PAT -2.6/+0.6
Recommendation Rationale
• Asset Quality pressures to ease in H2FY26; Credit costs guidance revised upwards: AUSFB’s overall credit costs tapered QoQ to stand at 1.94% (vs 2.42% QoQ); however, the credit costs in the unsecured portfolios continue to remain elevated. Additionally, apart from the lower collection efficiency (CE) in the MFI book, owing to the more stringent MFIN guardrails, the management has flagged concerns in the mortgage book in the southern states (eFincare book, stress likely owing to the transition). The bank has taken appropriate steps to strengthen the collections and expects a pull-back in H2FY26. On the MFI front, the CE has improved MoM, and the trend is expected to continue. The management expects MFI credit costs to peak out in Q2FY26 and improve thereafter. Currently, the asset quality in the credit card portfolio continues to remain elevated, but the bank’s corrective actions have ensured better quality in new acquisitions for both NTB and ETB customers. The credit costs in the credit card portfolio have peaked and should recede from Q2FY26 onwards. The asset quality trends in the secured businesses are not a cause of concern. However, given the delay in MFI recovery being pushed back by another quarter, credit costs (to total assets) are expected to rise by another 10-15 bps and settle at 1% in FY26.
• Near-term NIMs under Pressure; FY27 NIMs to be Higher: NIM pressures during the quarter were visible owing to a sharp decline in asset yields (27 bps), decline in investment yields (20- 25 bps) and excess liquidity (~10 bps). The management expects another quarter of pain before NIMs witness improvement from Q3FY26 onwards. Currently, ~70% of AUSFB’s portfolio is fixed rate and should benefit in the declining rate cycle. NIM improvement will be driven by declining CoF. The bank has seen a marginal 6 bps CoF improvement in Q1FY26. Further improvement will be led by the rate action taken with peak SA rates reduced 50 bps (~100 bps in certain buckets) and peak TD rates slashed by 90 bps. While some recovery in NIMs is possible in H2FY26, margins are slated to improve meaningfully in FY27E. We expect AUSFB’s margins to improve to range between 5.5-5.6% over FY26-28E.
• Controlled Opex: AUSFB will continue to exercise discipline over Opex growth as it intends to keep the C-I Ratio under 60% and expects the C-A Ratio to improve in FY26 vs FY25. The bank’s focus remains on improving productivity and rationalising expenses on digital marketing and branding. AUSFB plans to add 70-80 deposit branches in FY26, primarily in major cities. We expect the C-I Ratio to remain range-bound between 54-55% over FY26-28E, supported by balanced Opex growth
Sector Outlook: Positive
Company Outlook: The bank is marching towards achieving its FY27E RoA target of 1.8%, with tight control on costs and focused efforts on improving asset quality to drive meaningful improvement in credit costs. While another quarter of pain on NIMs will continue, we expect some support of margins from H2FY26 and beyond, driven by a ~70% fixed rate book, downward repricing of CoF with rate action reflecting and growth resumption in the higher-yielding unsecured products. Supported by healthy business growth, margin improvement slated for FY27, controlled opex growth, and gradually moderating credit costs, AUSFB is expected to deliver RoA/RoE of 1.6- 1.8%/15-18% over FY26-28E.
Current Valuation: 3.0x FY27E ABV Earlier Valuation: 2.5x FY27E ABV
Current TP: Rs 900/share, Earlier TP: Rs 755/share
Recommendation: We maintain our BUY recommendation on the stock.
Financial Performance:
? Operational Performance: Advances grew by 23/3% YoY/QoQ, with healthy growth across secured segments. The secured loans grew by 22/3% YoY/QoQ. Unsecured businesses de-grew by 23/7% YoY/QoQ, driven by industry-wide de-leveraging in MFI, along with implementation of MFIN guardrails and corrective actions taken in Credit Cards. Deposit growth was strong at 31/3% YoY/QoQ, with strong growth in both TDs (+39/3% YoY/QoQ) and CASA Deposits (+16/3% YoY/QoQ). CASA Ratio stood at 29.2%, flat QoQ. LDR stood at 87.4% vs 87.5% QoQ.
? Financial Performance: NII grew by 6/-2% YoY/QoQ, with NIMs contracting by 38 bps QoQ (sharper contraction than expected). NIMs (reported) stood at 5.4% vs 5.8% QoQ. Non-interest income grew by 49/7% YoY/QoQ, led by treasury gains. Opex grew by 4/-1% YoY/QoQ, with the bank exercising control on costs. C-I Ratio declined to 54% vs 54.7% QoQ. PPOP grew by 33/2% YoY/QoQ. Credit costs moderated to 1.94% vs 2.42% QoQ, though credit costs in the unsecured portfolios continue to remain elevated. Higher credit costs in the secured book were owing to seasonality. PAT grew by 15/16% YoY/QoQ.
? Asset Quality deteriorated with GNPA/NNPA inching up to 2.47/0.88% vs 2.28/0.74% QoQ. Slippages inched up sequentially, with the slippage ratio at 3.8% vs 3.5% QoQ. PCR stood at 83% incl. TWO.
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