Integration Of Fincare Branches And Renewable Energy Focus Will Strengthen Future Prospects

Key Takeaways

• Integration of Fincare's branches and expansion plans aim to enhance AU Small Finance Bank's revenue, distribution efficiency, and deposit growth.
  
• Strategic focus on secured retail assets, government-backed microfinance, and growing sectors to boost asset quality, net margins, and diversify revenue.
  
• Economic challenges, higher credit costs, and market competition impact AU Small Finance Bank's revenue growth, margins, and long-term financial stability.

Catalysts

Engages in the provision of various banking and financial services in India.

• The integration of Fincare's branches into AU Small Finance Bank's operations is expected to drive productivity and growth starting next year, particularly in key southern markets, enhancing both revenue and distribution network efficiency.
  
• AU Small Finance Bank's strategic focus on high-growth secured retail assets, such as wheels and mortgages, provides a long-term growth runway with strong asset quality and yields expected to improve, potentially boosting both revenue and net margins.
  
• The bank's initiative to secure government guarantees for a higher portion of its microfinance (MFI) and small marginal farmers (SMF) lending is anticipated to reduce risk weights and future credit costs, thereby enhancing net margins over time.
  
• AU Small Finance Bank plans to expand its branch network by opening 70 to 80 new branches and enable existing asset centers to accept deposits, which should drive deposit growth and optimize the cost of funds, positively impacting net interest margins.
  
• The bank has identified strategic opportunities in the growing sectors of renewable energy and infrastructure within commercial banking, which should foster asset diversification and support revenue growth, while also enhancing cross-sell opportunities through its AD-I business.

AU Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AU Small Finance Bank's revenue will grow by 26.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 23.8% today to 23.6% in 3 years time.
• Analysts expect earnings to reach ₹39.7 billion (and earnings per share of ₹53.43) by about January 2028, up from ₹19.7 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 18.5x on those 2028 earnings, down from 22.5x today. This future PE is greater than the current PE for the IN Banks industry at 9.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.22%, as per the Simply Wall St company report.

AU Small Finance Bank Future Earnings Per Share Growth

Risks

• The persistent economic slowdown, coupled with tight liquidity and elevated inflation, could continue to suppress overall credit demand, potentially impacting revenue growth.
  
• Higher credit costs in microfinance and credit card segments, due to overleveraging and historical underwriting issues, pose a risk to net margins as these segments experience elevated delinquency rates and slippages.
  
• Intense competition in deposit mobilization pressures the cost of funds, which may limit net interest margin improvements and subsequently impact earnings.
  
• The reliance on external market dynamics, including anticipated interest rate cuts and economic recovery, poses a risk to achieving target ROA, impacting long-term profitability if these conditions do not materialize.
  
• Challenges in scaling unsecured lending segments sustainably, amidst recent operational setbacks, may lead to increased volatility in overall earnings and hinder the achievement of long-term financial goals.

Valuation

• The analysts have a consensus price target of ₹663.96 for AU Small Finance Bank based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹880.0, and the most bearish reporting a price target of just ₹500.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹168.4 billion, earnings will come to ₹39.7 billion, and it would be trading on a PE ratio of 18.5x, assuming you use a discount rate of 14.2%.
  
• Given the current share price of ₹595.95, the analyst's price target of ₹663.96 is 10.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.