Rebalancing Loan Portfolios And Investing In Tech Will Optimize Operations

Key Takeaways

• Strategic shift from Microfinance to Small Business and Used Vehicle finance could stabilize credit costs and enhance revenue through profitable growth.
  
• Technology investments' completion and deposit repricing may improve net margins, supporting earnings potential and enhanced RoA by FY '26.
  
• Elevated credit costs and increased operating expenses are impacting profit margins, with competition and risks in loan segments threatening future revenue growth.

Catalysts

Provides various banking products and services to for individuals and corporates, and micro, small, and medium enterprises in India.

• The reduction in Microfinance portfolio, expected to drop from ₹4,500 crores in March '25 to ₹3,000 crores by March '26, should minimize the impact of future headwinds in the Microfinance sector, potentially stabilizing credit costs and improving net margins.
  
• The growth in Small Business Loans, Used Cars, and Used Commercial Vehicle (CV) finance, which are growing profitably with controlled credit costs, could enhance overall revenue and help offset reductions in the Microfinance book.
  
• The stabilization and expected decline in the cost of funds as deposit repricing takes effect could improve net margins, aiding in enhancing the bank's overall earnings.
  
• Investments in technology and operations, such as the CRM, native IBMB app, credit cards, and AD-I projects, have been largely completed, suggesting that lower incremental investment could improve operational efficiencies and enhance net margins.
  
• The anticipated growth in RoA to over 1% by the end of FY '26, driven by improved collection efficiencies and strategic realignment away from Microfinance, indicates potential for better earnings performance in the future.

Equitas Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Equitas Small Finance Bank's revenue will grow by 15.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 3.5% today to 19.4% in 3 years time.
• Analysts expect earnings to reach ₹12.4 billion (and earnings per share of ₹10.18) by about August 2028, up from ₹1.5 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting ₹14.8 billion in earnings, and the most bearish expecting ₹10.5 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.3x on those 2028 earnings, down from 44.1x today. This future PE is lower than the current PE for the IN Banks industry at 12.2x.
• Analysts expect the number of shares outstanding to grow by 1.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.73%, as per the Simply Wall St company report.

Equitas Small Finance Bank Future Earnings Per Share Growth

Risks

• The high credit costs in the Microfinance portfolio, increasing from 2.3% in FY '24 to 11.37% in FY '25, led to significant profit erosion, impacting net margins.
  
• The deliberate reduction in the Microfinance book resulted in lower income, adversely affecting the return on assets (RoA) to a mere 0.32% for FY '25, potentially lowering overall earnings.
  
• The decline in net interest margins (NIMs) from 8.36% to 7.51% due to changes in loan book composition could strain future revenue growth.
  
• Operating expenditure increased by 15% for the year, with cost-to-income rising, which could hinder improvements in net margins and profitability.
  
• Rising competition and slippage ratios, especially in the Small Business Loans (SBL) segment and new product execution risks, could pressure future revenue and retention of market share.

Valuation

• The analysts have a consensus price target of ₹74.556 for Equitas 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 ₹98.0, and the most bearish reporting a price target of just ₹60.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹63.8 billion, earnings will come to ₹12.4 billion, and it would be trading on a PE ratio of 10.3x, assuming you use a discount rate of 12.7%.
• Given the current share price of ₹56.92, the analyst price target of ₹74.56 is 23.7% 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.