Leveraging Fincare's Network And Universal Bank License Upgrade Will Drive Earnings Growth

Key Takeaways

• Expansion in informal self-employed segments and leveraging Fincare's network are expected to drive revenue growth and earnings.
  
• Improving cost-to-income ratios and expanding fee-based income sources aim to enhance profitability and support future earnings.
  
• Dependence on informal sectors and heightened credit costs pose risks to AU Small Finance Bank's earnings, profitability, and capital due to regulatory and competitive challenges.

Catalysts

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

• The bank anticipates a pickup in economic activity and consumer confidence in the latter half of the year, which could drive revenue growth, particularly in the informal self-employed customer segments.
  
• AU Small Finance Bank is leveraging Fincare's distribution network to increase product coverage, which is expected to enhance disbursement volumes and potentially boost the bank's earnings.
  
• The bank's focus on improving cost-to-income ratios, evidenced by a reduction from 61% to 57% quarter-on-quarter, indicates a commitment to improving net margins through cost efficiencies.
  
• Plans to monetize investments and expand fee-based income sources, including insurance distribution and wealth management, are intended to contribute to net interest income and other income streams, thereby supporting future earnings.
  
• An anticipated upgrade to a Universal Bank license is expected to strengthen the bank's brand and deposit franchise, potentially leading to increased revenue from a larger and more diversified customer base.

AU Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AU Small Finance Bank's revenue will grow by 31.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 23.4% today to 23.2% in 3 years time.
• Analysts expect earnings to reach ₹40.5 billion (and earnings per share of ₹54.52) by about December 2027, up from ₹18.2 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as ₹30.5 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 19.5x on those 2027 earnings, down from 22.8x today. This future PE is greater than the current PE for the IN Banks industry at 12.9x.
• 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 14.15%, as per the Simply Wall St company report.

AU Small Finance Bank Future Earnings Per Share Growth

Risks

• The operating environment has been challenging due to persistent high inflation, election cycles, and adverse weather, which have impacted business activity, especially within the informal self-employed customer segments. This could negatively affect revenue and cash flows.
  
• There is a significant reliance on informal self-employed customer segments, making AU Small Finance Bank sensitive to any disruptions in economic activity, potentially impacting earnings and net margins.
  
• Elevated credit costs are expected in the unsecured lending and MFI (microfinance institution) segments, with these costs currently exceeding expectations. This could pressure earnings and net margins if the trend continues despite efforts to manage these risks.
  
• Competitive pressures or inadequate risk management in the unsecured lending segments, such as in credit cards and MFI, could lead to further delinquencies, impacting profitability and potentially straining capital reserves.
  
• Regulatory risks, such as RBI circulars on foreclosure charges or unforeseen changes in asset quality norms, could impact revenue and profit margins, particularly if they necessitate revisiting existing fee strategies or provisioning norms.

Valuation

• The analysts have a consensus price target of ₹715.91 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 ₹590.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be ₹174.4 billion, earnings will come to ₹40.5 billion, and it would be trading on a PE ratio of 19.5x, assuming you use a discount rate of 14.1%.
• Given the current share price of ₹558.35, the analyst's price target of ₹715.91 is 22.0% 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.