Key Takeaways

Expansion into new branches and leveraging tech innovations could boost revenue and improve long-term efficiency and net margins.
Applying for a universal banking license and strategies to reduce credit volatility may create opportunities for growth and earnings enhancements.
AU Small Finance Bank faces challenges like elevated costs from wholesale deposits, credit costs, and integration issues, potentially impacting margins and revenue growth.

Catalysts

About AU Small Finance Bank

Engages in the provision of various banking and financial services in India.What are the underlying business or industry changes driving this perspective?

AU Small Finance Bank's plans to open 70 to 80 new branches and enable 75 asset centers to take deposits could potentially lead to an increase in deposit growth, positively impacting revenue.
The focus on tech and digital channels, including AI and automation, is expected to drive long-term efficiency improvements, potentially leading to an increase in net margins.
Expansion into South India utilizing Fincare touchpoints and the commercial banking segment's strategy to integrate with the deposit franchise could enhance revenue growth.
AU's application for a universal banking license, if granted, would likely provide new opportunities for business expansion, potentially increasing earnings.
The strategic decision to cover a significant portion of the MFI book under the CGFMU credit guarantee scheme is expected to reduce credit cost volatility, potentially leading to improved net margins.

AU Small Finance Bank Earnings and Revenue Growth

AU Small Finance Bank Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

Analysts are assuming AU Small Finance Bank's revenue will grow by 29.1% annually over the next 3 years.
Analysts assume that profit margins will shrink from 24.1% today to 23.0% in 3 years time.
Analysts expect earnings to reach ₹43.2 billion (and earnings per share of ₹58.0) by about May 2028, up from ₹21.1 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹48.1 billion.
In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.0x on those 2028 earnings, down from 24.0x today. This future PE is greater than the current PE for the IN Banks industry at 10.7x.
Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
To value all of this in today's terms, we will use a discount rate of 14.01%, as per the Simply Wall St company report.

AU Small Finance Bank Future Earnings Per Share Growth

Risks

What could happen that would invalidate this narrative?

The challenging macroeconomic environment and tight monetary policy with elevated interest rates have weighed on credit demand and increased the cost of funds, which could impact net margins and revenue growth.
AU Small Finance Bank's dependency on wholesale deposits to drive deposit growth may put pressure on net interest margins, as wholesale deposits generally have higher costs compared to retail deposits.
Elevated credit costs, particularly in the Microfinance (MFI) and credit card segments, have been significant, and any delay in the normalization of credit costs could negatively affect earnings.
The bank's loan portfolio growth in secured segments might face pressure if systemic credit growth remains moderate, limiting revenue growth potential.
Potential challenges in successfully integrating Fincare deposits and the new branches could increase operational expenses and impact the bank's cost-to-income ratio.

Valuation

How have all the factors above been brought together to estimate a fair value?

The analysts have a consensus price target of ₹672.75 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 ₹831.0, and the most bearish reporting a price target of just ₹471.0.
In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹188.1 billion, earnings will come to ₹43.2 billion, and it would be trading on a PE ratio of 21.0x, assuming you use a discount rate of 14.0%.
Given the current share price of ₹678.6, the analyst price target of ₹672.75 is 0.9% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
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.