AU Small Finance Bank eligible to apply for universal bank status. Should you invest in the stock?

[view original post]

NEW DELHI: AU Small Finance Bank (SFB), which has completed five years of operations and is now eligible to apply for a universal banking licence, could not enthuse investors with its March quarter results, even as the lender reported a nearly two times year-on-year earnings growth led by 40 per cent YoY growth in operating profit and nearly 35 per cent decline in provisions.

Analysts said a strong AUM growth of 27 per cent YoY, improvement in asset quality performance with gross NPA back to pre-Covid levels of less than 2 per cent, and a rise in provision coverage ratio (PCR) to 75 per cent, were all positives.

But AU’s numbers missed Street estimates on core pre-provision operating profit (PPOP), with elevated cost-income of 61 per cent.

Besides, around 75 per cent of AU SFB’s assets book carry fixed rate of interest and only 25 per cent carry floating rate and brokerages such as Emkay Global see margin headwinds ahead.

What makes a few analysts worry more is the prevailing stock valuations, which they find expensive after a 28 per cent rally on the counter this year. For them, most positives have been baked in the stock price.

The growth is recovering well but needs a bit more support from core segments to give greater comfort on profitability, given higher run-rate of investments and usual lag in payoffs, said Kotak Institutional Equities in a note.

“Franchise is steadily gaining strength but expensive valuations and better alternatives within coverage drive our ‘sell’ rating,” the brokerage, which has a target of Rs 1,150 on the stock, said.

AU Small Finance Bank reported a doubling of net profit at Rs 346 crore in March quarter compared with Rs 169 crore in the same quarter last year. Net interest income (NII) rose 43 per cent YoY to Rs 937 crore. The net interest margin came in at 6.3 per cent against 5.7 per cent in the year-ago quarter.

Nomura India said AU’s journey towards transitioning towards a universal bank, a continued ramp-up in liabilities and investments in digital capabilities in addition to its asset moats add legs to the story. It expects AU to deliver 27-28 per cent EPS CAGR over FY22-25, with return on equity (RoE) improving to 18 per cent levels as opex drags normalise.

“That said, valuations at over 4 times FY24 book fairly prices in the positives, in our view. We, hence, maintain our neutral stance and await a better entry point,” it said while suggesting a target of Rs 1,400 from Rs 1,375 earlier.

The bank has increased the number of independent directors to eight to allay concerns around corporate governance and exits in the audit/risk management team.

But Emkay Global believes AU SFB runs a high growth-risk model, and thus should strengthen its compliance architecture and build higher counter-cyclical buffers, more so in light of its planned transition toward a universal bank. This brokerage has ‘Hold’ rating on the stock with a target of Rs 1,340 from Rs1,275 earlier, valuing the bank at 4.2 times FY24.

YES Securities said sustained intense franchise investments would likely augment long-term growth and profitability prospects of the bank but would cap return on asset (RoA) expansion in near-term.

“We have raised earnings and ABV estimates on higher growth and lower net NPLs (provisioning policy change). Retain ADD rating with an increased 12m price target of Rs 1,505,” it said.

The target on the stock suggests limited upside on the counter over Thursday’s intraday price of Rs 1,382.20.