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Spread compression and elevated Opex weigh on RoE

Slightly weak core performance in the quarter

Aavas delivered a 2%/7% miss on core NII/PPOP (ex. of DA income) as Portfolio Spread compression was significant reflecting loan pricing, funding cost and BT pressures, and non-employee opex continues to increase on implementation of new LMS and ERP. Disbursements improved as was expected (up 8% qoq), but the volume was marginally short of our expectation. However, AUM growth was steady at 5% qoq/23% yoy as portfolio run-off rate came-off for second consecutive quarter. Portfolio Spread contracted further by 20 bps qoq from 5.3% to 5.1%, after having compressed by 30 bps in the preceding quarter. The decline was caused by increase in CoF and reduction in Portfolio Yield (fell by 20 bps over past 2Qs). The pressure on Portfolio Yield is from competitive rates for new loans and repricing of BT requests. Incr. CoF moderated in the quarter with to around 8% with co. availing the NHB sanctions. Non-employee Opex grew 8% qoq/29% yoy with Phase-2 investments being done on implementation of new LMS (Flexcube) and ERP (Oracle Fusion). Notably, Branch addition has been low so far in the year. Slight increase was seen in 1+ dpd (from 3.58% to 3.75%) and Stage-3 assets (from 1.04% to 1.1%) causing marginal uptick in provisions. Write-offs continue to be marginal at ~Rs30mn and ECL coverage was largely maintained across buckets.

Confident of delivering 22-25% pa growth and sustaining spreads above 5%

1 lakh+ login applications have been successfully processed under the new Salesforce LOS, and Rs.45bn+ worth of cases have been sanctioned. Login to Sanction TAT has come down. Oracle Fusion ERP system has been made live in Sept’23 and in under stabilization. New LMS (Flexcube) is under testing and migration. So, the major tech transformation would get complete in next 3-4 months. As per the Management, disbursement throughput is improving MoM and in January the disbursement value was higher 20-25% yoy. Besides enlarging the execution capacity by multi-fold, Aavas is taking initiatives for augmenting non-branch sourcing through eMitra and digital channels. Management is also reenergizing its core product (low-ticket high-yielding HL) and aspires to improve its origination share by 5 ppt. All the efforts on tech/system changes, sourcing expansion and product focus sharpening is likely to generate stronger growth outcomes from FY25. Management intends to double AUM over next three years. With incremental borrowing rate peaking and focus on increasing the business contribution of small-ticket HL, the Portfolio Spread is expected to be sustained above 5% over the medium term. Management also believes that higher-scale execution post tech transformation would increase branch/resource productivity and gradually improve the opex metrics.

Earnings have been cut; see a more gradual RoE improvement

Our FY24/25/26 earnings estimates get cut by 4-8% on lowering expectation of sustainable portfolio spread. We believe that delivery of 22-23% pa AUM CAGR should not be a challenge considering benefits from expansion of lead funnel and augmentation of business execution capacity after tech transformation. Key monitorables for immediate quarters would be recovery in disbursement growth and stabilization of portfolio spread around the current level. Though valuation at 2.4x P/ABV and 16x PE on FY26 is not expensive, a more gradual RoE improvement trajectory is likely to preclude any significant re-rating. Maintain Neutral rating on Aavas with 12m PT of Rs1615.

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