Buy Five-Star Business Finance Ltd for the Target Rs 600 by Motilal Oswal Financial Services Ltd
Stress cycle behind, growth cycle ahead Collection trends improving, and business momentum gaining traction
Five-Star Business Finance (Five-Star) has exited a year of portfolio repair and has entered a phase of calibrated growth, supported by improving collections, stabilizing asset quality, and recovering disbursement momentum, while retaining one of the highest profitability profiles in the secured lending universe.
* Five-Star appears to be transitioning from a year of portfolio stabilization toward a more balanced growth phase, underpinned by improving collection trends, moderation in fresh stress formation, recovery in disbursement momentum, and strengthening business activity across its core markets.
* FY26 was one of the most challenging years for the company, as stress originating from unsecured lending and the MFI segment spilled over into micro-LAP. In response, management consciously prioritized collections, portfolio quality, and borrower discipline over near-term growth. With collection trends improving materially and portfolio behavior stabilizing, the company is now gradually shifting its focus back to growth while maintaining a disciplined underwriting approach.
* We expect disbursements in 1QFY27 to exceed INR14b (PQ: ~INR12.1b), marking the first time the company reaches these levels since 4QFY25. While AUM growth (we estimate ~10% YoY as of Jun’26) may appear relatively muted due to a higher base effect, we expect AUM growth to pick up momentum over the coming quarters. We model an AUM CAGR of ~21% over FY26-FY28E.
* Collection performance has strengthened steadily over the past few months, with overall collection efficiency expected to exceed 98% in 1QFY27. More importantly, current bucket’s collection efficiency has consistently remained above 99%, indicating meaningful moderation in fresh stress formation and improving borrower repayment behavior. With collection trends approaching historically healthy levels, we believe the company has largely moved beyond the peak of the stress cycle, setting the stage for a gradual normalization in asset quality and credit costs.
* On the profitability front, management expects portfolio yields to decline 50-60bp over the next few quarters before stabilizing. Consequently, spreads could compress by 30-35bp, resulting in NIM moderation. We estimate NIMs of 18.8%/18.1% in FY27/FY28E (vs. 19.4% in FY26).
* We believe Five-Star is well positioned to return to a healthier growth trajectory over FY27, supported by strong branch economics, improving traction across southern markets, and deeper penetration into its newer geographies. The stock currently trades at 1.7x FY27 P/BV. We estimate Five Star to deliver a CAGR of ~21%/12% in AUM/PAT over FY26-28E, along with RoA/RoE of 6.6%/15% in FY28E. We reiterate our BUY rating on the stock with a TP of INR600 (premised on 1.8x Mar’28E P/BV).
Yield compression nearing an end; NIM to moderate
* Despite a ~200bp decline in disbursement yields over the past 18 months, spreads have remained broadly resilient, aided by a favorable funding environment and lower borrowing costs. However, management expects the benefit from declining funding costs to moderate going forward.
* Borrowing costs are anticipated to remain broadly stable in 1QFY27, although the incremental cost of funds could rise ~15-20bp as Five-Star raises a larger share of funding from banks and institutional lenders. On the asset side, portfolio yields are likely to dip by another ~50-60bp before stabilizing at around 22%.
* As a result, management expects spreads to compress by ~30-35bp over the next one year. Consequently, NIMs are also likely to moderate, reflecting both spread compression and the impact of increasing leverage. Management expects spreads to stabilize around ~13.5%. We estimate NIMs of 18.8%/18.1% in FY27/FY28 compared with 19.4% in FY26.
Valuation and view
* We believe FY26 represented a cyclical normalization phase rather than a structural impairment of Five-Star's business model. Improving collection trends, moderation in fresh stress formation, stable portfolio performance across key markets, and recovering disbursement momentum reinforce our view that the company has largely moved beyond the peak of the stress cycle.
* Management has navigated the challenging environment with a conscious focus on portfolio quality, collections, and organizational preparedness rather than pursuing growth at the expense of risk discipline. With collection trends stabilizing and business momentum improving, we believe Five-Star is now transitioning from a phase of stabilization to one of calibrated growth.
* The stock currently trades at 1.7x FY27E P/BV. We estimate Five-Star to deliver an AUM/PAT CAGR of ~21%/12% over FY26-28E, while generating RoA/RoE of 6.6%/15% in FY28E. We reiterate our BUY rating with a TP of INR600, based on 1.8x Mar'28E P/BV.
* Key risks:
1) Slippages remaining at elevated levels
2) A slower-thananticipated recovery in disbursement growth if portfolio normalization takes longer to sustain
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