Reduce AU Small Finance Bank Ltd for the Target Rs.875 By Emkay Global Financial Services Ltd
After a soft Q2, AU SFB bounced back in Q3 and reported nearly in-line PAT at Rs6.7bn/1.6% RoA. This was mainly due to better growth/margin and lower provisions, partly offset by higher opex (C/I ratio at a high of 60%), as it transitions toward becoming a retail-heavy Universal Bank. Overall asset quality is trending well, with GNPA ratio steadily moderating to 2.3%, benefiting from contained slippage and strong credit growth. However, specific PCR has now slipped to a low of 62% to support profitability, which is slightly disappointing, more so in view of the ensuing ECL implementation in AU. We largely retain our earnings estimates for FY26-28E, with our RoA assumptions steadily improving to 1.5-1.7%, but managing operational cost will be key to sustaining the momentum. We retain REDUCE and TP of Rs875, as current valuations (3.4x/2.9x FY27E/FY28E ABV) are running ahead of fundamentals.
Growth improves and so does margin
AU SFB has accelerated its credit growth to 24% YoY (AUM growth at 19% YoY from 17% in 2Q) with meaningful contribution from the wheels segment, in turn benefiting from the recent GST rate cut. Though overall unsecured loan growth remains subdued, MFI portfolio has started to turn the corner. However, deposit growth lagged and, thus, LDR expanded to a high of 89%. Moreover, CASA growth remains relatively moderate; hence, the bank remains heavily dependent on bulk TD growth to fund its credit quest. However, it managed to report 20bps QoQ improvement in NIM on the back of the reduction in CoF, benefiting from SA rate and CRR cut. The management expects margin trajectory to improve in the medium term, but for a potential rate cut in Q4.
Unsecured loan stress eases a bit; specific PCR slips further
Fresh slippage moderated to Rs7.9bn/3.2% of loans, given the easing stress in unsecured loans and seasonal recovery in secured assets. Within unsecured retail loans, the management indicates that incremental stress in the MFI portfolio is easing and thus should further drive down slippage. However, overall specific PCR slipped further to a low of 62%, which is slightly disappointing. The management claims that rising CGFMU cover in the inclusive banking segment provides comfort on trimming the specific PCR – we believe this may not be the right approach given the track record of claims with CGFMU.
We retain REDUCE with unchanged TP of Rs875
We believe the bank’s plan to transition toward secured loans and elevated operational cost in the run up to its transition into a Universal Bank could limit RoA to 1.5-1.7% over FY26-28E, while valuations are running ahead of fundamentals. Thus, we retain REDUCE with unchanged TP of Rs875, based on 2.5x Dec-27E ABV. Key risks to our rating/estimates: faster-than-expected growth and margin/asset quality turnaround, coupled with lower operational burn in its transition into a Universal Bank
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