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Collections holding up well and credit costs still benign

AUM growth moderated to ~25% YoY; minor deterioration in asset quality

* Five Star Business Finance (FIVESTAR)’s 3QFY25 PAT grew 26% YoY to INR2.74b (in line). NII grew ~28% YoY to INR5.4b (in line), while PPoP rose ~29% YoY to INR3.9b (in line). Other income declined 3% YoY to INR198m.

* Opex grew 21% YoY to INR1.7b (in line). Credit cost stood at INR233m (~13% lower than est.). Annualized credit cost was stable QoQ at ~70bp (PY: ~50bp).

* Management guided for AUM growth of ~25% for FY25. However, the company will revisit the business outlook for the next year at the end of the March quarter and provide guidance for the next fiscal year.

* Overall Collection Efficiency (CE) stood at 98% (PQ: 98.4%). Unique loan collections (Due one, collect one) stood at 96.7% (PQ: 97%). FIVESTAR does not foresee any further significant deterioration in asset quality and expects no substantial increase in credit costs for 4QFY25. While credit costs have recently been in the band of ~70bp, its business model is designed to function effectively with credit costs of ~75-100bp.

* Management shared that the income of FIVESTAR customers has not been impacted. However, the collection efforts required have increased. The rise in 30+dpd by ~70bp QoQ is primarily attributable to overleveraging from unsecured retail loans (including MFI). The company does not expect MFIN guardrails 2.0, if implemented from Apr’25, to have any significant impact on its collections.

* FIVESTAR has successfully navigated the current mini credit cycle (due to unsecured retail), much to our pleasant surprise, with both GS3 and credit costs remaining within the expected range. While there are early green shoots of improvement in the MFI sector and unsecured PL, we now attach a higher probability that FIVESTAR will emerge relatively unscathed from this tough macro environment. Our earnings estimates remain largely unchanged. FIVESTAR has developed strengths and capabilities in its business model that are difficult for peers to replicate. We anticipate that the company will maintain its best-in-class profitability, with a CAGR of ~26%/~20% 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 its RoA profile). Reiterate BUY with a TP of INR930 (based on 3.3x Sep’26E BV).

Reported NIMs and spreads decline sequentially

* Reported yield declined ~20bp QoQ to 24%, while CoB was stable QoQ at 9.6%. Reported spreads declined ~20bp QoQ to 14.35%. Reported NIM contracted ~35bp QoQ to ~16.55%.

* Incremental CoF was stable QoQ at ~9.6%. The company reduced the yields on incremental loans during the quarter, which led to a slight contraction in both NIMs and spreads for the period. We model NIMs to decline to 18.3%/17.2% in FY26/FY27E (FY25E: 19.4%).

Asset quality deteriorates; cash component in collection declines

* GS3/NS3 rose ~15bp/10bp QoQ to ~1.6%/0.8%. PCR declined ~160bp QoQ to ~50.2%. The current portfolio declined to 84.9% (PQ: 86%). Stage 2 rose ~55bp QoQ to ~7.5%.

* 30+ dpd rose ~70bp QoQ to ~9.15% and 1+dpd increased ~110bp QoQ to 15.1%. The company is confident that 30+dpd will largely remain stable at current levels and not exhibit any significant increase from hereon.

* Cash collections declined to ~24% (PQ: ~28% and PY: ~52%) due to the company’s strong efforts to reduce cash collections.

Disbursements moderate; AUM grows ~25% YoY

* Disbursements declined ~22% YoY and ~25% QoQ to ~INR9.4b; AUM grew 25% YoY/2% QoQ to ~INR112b. Moderating the quarterly disbursement in 3Q was a conscious strategy to moderate the portfolio growth for this financial year.

* 3QFY25 RoA/RoE stood at 8.1%/18.5%. Capital adequacy stood at ~51.2% as of Dec’24.

Highlights from the management commentary

* LGD for FIVESTAR continues to be fairly low at 10-12%. The company offers a fully secured mortgage product and will ensure that the overall provision coverage does not drop.

* NBFC Sector/Banking Sector experienced a decline in collections in Oct/Nov’24. For FIVESTAR as well, collections in Dec'24 picked up well and this trend has continued into Jan’25. The company expects 4Q to perform better than 3Q.

* FIVESTAR continues to be a highly attractive institution for lenders, with new partnerships established during the quarter, including HDFC MF, HSBC MF, and SIDBI. Additionally, SBI has extended fresh sanctions amounting to INR5b.

Valuation and view

* FIVESTAR reported a weak business momentum in 3QFY25. The company reported AUM growth of ~25% YoY, in line with its guidance to moderate growth momentum given the current weak macro environment and overleverage from unsecured retail. Interestingly, while asset quality deteriorated with GS3 rising ~15bp QoQ due to a minor sequential decline in collection efficiency, credit costs remained broadly stable QoQ at ~70bp.

* The stock currently trades at 2.4x FY27E 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 ~26% AUM CAGR over FY24-FY27, along with NIM (as a % of average loans) of 18.3%/17.1% 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 reiterate our BUY rating on the stock with a TP of INR930 (premised on 3.3x Sep’26E BVPS).

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