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Macros prompt a cut in AUM growth guidance

Earnings in line but disbursements moderate; lending rate to be cut by ~2pp

* Five Star Business Finance (FIVESTAR)’s 2QFY25 PAT grew 34% YoY to INR2.7b (in line). 1HFY25 PAT grew by ~36% YoY and we expect 2HFY25 PAT to grow by ~24% YoY. NII grew ~30% YoY to INR5.2b (in line), and PPoP rose ~37% YoY to INR3.8b (in line).

* Opex grew 17% YoY to INR1.6b (in line). Credit costs stood at INR218m (~28% above MOFSLe). This translated into annualized credit cost of ~80bp (PY: ~50bp and PQ: ~70bp).

* Considering the current macro environment and the regulator’s view, FIVESTAR has decided to moderate its AUM growth and lowered its AUM growth guidance to ~25% for FY25.

* In addition, effective Nov’24, FIVESTAR has decided to reduce its lending rates by ~2pp to ~22.5%. Given the fixed-rate nature of these loans, the spread compression will happen only on the incremental disbursements. We model NIMs to decline to 18.3%/17.2% in FY26/FY27E (FY25E: 19.4%).

* We cut our FY26/FY27 PAT estimates by 3%/5% to factor in moderation in loan growth and a more accelerated compression in NIM. FIVESTAR has developed strengths and capabilities in its business model, which are difficult for peers to replicate. We anticipate that the company will maintain its best-in-class profitability, with a CAGR of ~28%/~21% in AUM/PAT over FY24-FY27E.

* FIVESTAR will command premium valuations relative to its NBFC/HFC peers due to its ability to deliver strong RoA/RoE of 7.1%/18% in FY27E (despite the moderation in return ratios). Reiterate BUY with a TP of INR1,015 (based on 3.6x Sep’26E BV).

Reported NIM up ~20bp QoQ; spreads stable QoQ

* Reported yield was flat QoQ at 24.2% and CoB was also stable QoQ at 9.7%. Reported spreads were stable QoQ at 14.5%. Reported NIM rose ~20bp QoQ to ~16.9% because of a minor decline in leverage.

* FIVESTAR is looking to increase its proportion of non-bank liabilities. To that end, it recently issued PTCs, which were subscribed to by a few large domestic mutual funds. The company has ~63% of its borrowings at a floating rate and ~37% are fixed rate in nature.

* The management guides for NIM of ~14%-15% and spreads of ~12%, on a normalized basis under steady state.

Asset quality largely stable; cash component in collection declines

* GS3 and NS3 increased ~5bp each QoQ at 1.5% and 0.7%, respectively. PCR declined ~25bp QoQ to ~51.8%. Stage 2 rose ~25bp QoQ to ~7%. 30+ dpd increased ~35bp QoQ to 8.45% and 1+dpd increased ~70bp QoQ to 14%. This was commendable given the quantum of stress in the microfinance segment.

* The cash proportion in collections declined ~28% (PQ: ~35% and PY: ~55%), because of strong efforts made by the company to reduce cash collections.

* The overall collection efficiency (CE) stood at 98.4% (PQ: 98.5%). Unique loan collections (due one, collect one) stood at 97% (PQ: 97.2%).

Disbursements moderated; AUM grew ~32% YoY

* Disbursements grew ~4% YoY and declined ~5% QoQ to~INR12.5b. AUM grew 32% YoY/6% QoQ to ~INR109.3b. 2QFY25 RoA/RoE stood at 8.4%/19% respectively. Capital adequacy stood at 48.7%.

Highlights from the management commentary

* FIVESTAR did a bureau scrub of all the primary applicants on active loans. ~13.7% of its loan accounts belong to customers who are over-leveraged with three or more loans with other financial institutions.

* The company has 1,600 loans (translating into ~0.4% of its total active loans), which have exhibited lower CE in the last six months. FIVESTAR has decided to implement stricter underwriting for over-leveraged customers.

Valuation and view

* FIVESTAR reported decent business momentum in 2QFY25. The company has decided to slow down its loan growth in FY25, considering the current environment and the view aired by the regulator on various public forums.

* The stock currently trades at 3.4x FY26E P/BV. We believe that FIVESTAR’s premium valuations will remain intact, given its niche market position, superior underwriting practices, resilient asset quality, and (still) high return metrics.

* We estimate FIVESTAR to deliver a ~28% AUM CAGR over FY24-FY27, along with NIM (as a % of average loans) of 18.3%/17.2% in FY26/FY27E.

* FIVESTAR’s asset quality is expected to remain relatively resilient compared to the stress that is witnessed in the unsecured lending segment. We expect credit costs to remain benign over FY25-FY26, as the company continues to prioritize digital collections. We reiterate our BUY rating on the stock with a TP of INR1,015 (premised on 3.6x Sep’26E BVPS).

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