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In-line quarter; collection efficiency improvement key monitorable

Fusion reported profits of INR 1.26bn (+4.3% QoQ, +32.2% YoY), in-line with our estimates. However, AUM growth was a tad soft (24.6% YoY, 7.5% QoQ) and credit cost remained relatively high (at 3.4% vs 3.6% QoQ). Continued NIM expansion to 11.12% (+23bps QoQ) led by moderation in marginal cost of borrowings aided the earnings performance for the quarter. AUM stood at INR 100.3bn on the back of softer disbursement trends (+14.2% YoY, +2.6% QoQ) impacted by unseasonal rains and floods. MFI AUM grew slower (+22.6% YoY, +2.8% QoQ) whereas MSME AUM grew rapidly (+104.7% YoY, +15.7% QoQ). Credit costs were elevated driven by high write-offs of INR 1.03bn and increase in management overlay by INR 102.3mn. Of the write-offs, ~30% emanated from the pre-Apr21 portfolio while balance has come through the post-Apr'21 portfolio. Lower collection efficiency in some of the states (highlighted in 1QFY24) such as Punjab, Rajasthan, etc is driving stress inflow for Fusion and mgmt. intends to recalibrate its collection strategy to drive better collection efficiency over the next couple of quarters. Mgmt. remains confident of restricting credit costs for FY24 at ~3% (after avg credit costs ~3.5% for 1HFY24). We build credit costs of 270bps (% of AUM) over FY24/FY25 (with 3% in FY24). Fusion's sticky credit costs will be a key monitorable over the next couple of quarters given that some of the similar sized peers have reported better collection efficiencies (though mgmt. had highlighted credit costs should trend meaningfully lower in 2HFY24 in 4QFY24 itself). We expect growth to accelerate given seasonally stronger second half and continued momentum on customer addition. We maintain BUY with a target price of target price of INR 700 (values Fusion at 2.1x FY25e P/BV).

* Soft AUM growth: In 2Q24, AUM stood at INR 100.3bn (+24.6% YoY, +3.2% QoQ) on the back of softer disbursement trends (+14.2% YoY, +2.6% QoQ) impacted by unseasonal rains and floods. Active borrower’s stands at 3.69mn with 0.16mn added in first half of the year. While Fusion has seen moderation in AUM growth in first half of the year, mgmt. expects growth to be backended with traction observed in Sep and Oct having an average disbursement of ~INR 8.5bn. We build AUM CAGR of 29% over FY24- 25E. Fusion’s overall unique customers stand at 31% (vs 34% as of Mar’23) and healthy trends are observed in the top 5 states hinting not much has changed on competition intensity front. Fusion reported an inline quarter with PAT at INR 1.26bn (+4.3% QoQ, 32.2% YoY) aided by controlled opex (cost to income at 36.4% flat QoQ) and slight moderation in credit costs (3.4% vs 3.6% QoQ). NIMs expanded by 23bps to 11.12% on account of increased proportion of higher yielding funds (+20bps) and improvement in marginal cost of borrowing (-10bps). We build EPS CAGR growth of 33% over FY24-25E.

* Write-offs remain elevated due to change in policy: GNPA/NNPA improved 52bps/13bps QoQ to 2.68%/0.65%, credit costs (to AUM) stood at 3.4% (-20bps QoQ) driven by high write-offs of INR 1.03bn and increase in management overlay by INR 102.3mn. Mgmt. cited that write-offs remained high on account of change in its policy from 360 to 270 days since 1Q24 and is expected to normalise by 4Q24. Of the write-offs, ~30% emanated from the pre-Apr21 portfolio while balance has come through the post-Apr'21 portfolio. Collection efficiency stood at 97.6% (+3bps QoQ) impacted by floods and unseasonal rains. Lower collection efficiency in some of the states (highlighted in 1QFY24) such as Punjab, Rajasthan, etc. is driving stress inflow for Fusion and mgmt. intends to recalibrate its collection strategy to drive better collection efficiency over the next couple of quarters. Coverage ratio stands at 73% and is expected to increase going forward. Mgmt. expects credit costs to normalise by 4Q24 to ~3%. We expect avg. credit costs of 270bps over FY24-25E.

* Valuation and view: Fusion is currently trading at 1.7x FY25E BVPS and we expect the stock to deliver superior return metrics of 4.7%/23.4% RoA/RoE for FY25E. Although, Fusion's sticky credit costs will be a key monitorable over the next couple of quarters given that some of the similar sized peers have reported better collection efficiencies (though mgmt. had highlighted credit costs should trend meaningfully lower in 2HFY24 in 4QFY24 itself). We expect growth to accelerate given seasonally stronger second half and continued momentum on customer addition. We maintain BUY with a target price of target price of INR 700 (values Fusion at 2.1x FY25e P/BV).

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