Technology Upgrades And High-Yield Small Business Loans Will Improve Future Profitability

Key Takeaways

• Focus on high-yield products and strong deposit franchise aims to improve profitability and boost net margins.
  
• Expansion and tech upgrades are set to enhance operational efficiency and drive long-term revenue growth.
  
• Rising credit costs and default risks may hamper growth and profitability due to lower collection efficiency and increased customer leverage in the microfinance sector.

Catalysts

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

• The introduction of a slab-based interest rate system in the Microfinance segment, offering rates based on borrower profiles, could stabilize and eventually increase yields over time as it attracts higher quality borrowers. This should improve net margins.
  
• The strategic focus on Small Business Loans (SBL) and Micro Loan Against Property (MLAP), which have a higher yield than standard loans, indicates a shift towards products with better internal profitability. This focus is likely to enhance overall earnings as the bank replaces lower-yielding Microfinance with these higher-yielding products.
  
• The ongoing development of a strong deposit franchise through the Liability 2.0 strategy aims to reduce the cost of funds over time. This includes cross-selling products to increase depositor stickiness, which should improve net interest margins and overall profitability.
  
• The implementation of advanced technology platforms and a revamped mobile banking application aims to enhance customer experience and operational efficiency. These initiatives can significantly reduce operating costs and improve the scalability of operations, positively impacting net margins.
  
• Expansion plans in states such as Andhra Pradesh, Telangana, and Karnataka for Small Business Loans (SBL) signify an untapped growth potential in these regions. Coupled with a solid track record in weathering economic challenges, such geographical diversification should contribute to stable and resilient revenue growth.

Equitas Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Equitas Small Finance Bank's revenue will grow by 17.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 7.6% today to 23.0% in 3 years time.
• Analysts expect earnings to reach ₹15.4 billion (and earnings per share of ₹13.49) by about March 2028, up from ₹3.1 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 8.3x on those 2028 earnings, down from 21.2x today. This future PE is lower than the current PE for the IN Banks industry at 9.2x.
• Analysts expect the number of shares outstanding to grow by 0.73% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.53%, as per the Simply Wall St company report.

Equitas Small Finance Bank Future Earnings Per Share Growth

Risks

• The recent drop in collection efficiency within the microfinance sector for Equitas Small Finance Bank, particularly dipping from 98.9% in Q1 to 98.2% in Q2, suggests inherent risks that could affect revenue due to increased credit costs from slippages.
  
• The discretionary cap on loans has escalated customer leverage, further compounded by app-based lenders, potentially elevating default risks and impacting net margins owing to increased provisions and credit losses.
  
• The decline in disbursements across microfinance, combined with uncertainties in reducing microfinance exposure, may hamper growth rates in the short term, thereby affecting overall earnings.
  
• The elevated SMA-2 levels from 2% to 2.73% indicate potential future slippages to NPA, which could maintain pressure on credit costs, impacting overall profitability.
  
• Changes in EMI rates in the Microfinance sector may lead to a reduction in yield by 100 to 150 basis points, affecting net interest income and profit margins.

Valuation

• The analysts have a consensus price target of ₹76.6 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 ₹100.0, 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 ₹66.8 billion, earnings will come to ₹15.4 billion, and it would be trading on a PE ratio of 8.3x, assuming you use a discount rate of 12.5%.
• Given the current share price of ₹58.08, the analyst price target of ₹76.6 is 24.2% 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.