Secured Loan Transition And Universal Bank Shift Will Improve Operations

Key Takeaways

• Transitioning to secured loans and applying for universal bank status could enhance margins, reduce credit costs, and diversify revenue streams.
  
• Focus on secured loans and new products like micro mortgages aims to balance interest margins and boost earnings through diversified growth.
  
• Ujjivan faces pressures on net interest margin, high credit costs, and increased expenses amidst uncertainties in portfolio diversification and regulatory challenges.

Catalysts

Provides various banking and financial services in India.

• Ujjivan Small Finance Bank is working to improve its credit quality by transitioning a significant portion of its loan portfolio towards secured loans, which could enhance net margins and reduce credit costs over time.
  
• The bank's application to transition to a universal bank could expand its operational capabilities and revenue streams, impacting future revenue positively.
  
• The bank's strategic focus on high-yielding secured loans like vehicle finance and micro mortgages, along with the positive momentum in micro banking individual loans, could balance net interest margins even with the shift to secured loans.
  
• The continued robust growth in secured asset segments such as housing and MSME, alongside new product offerings like micro mortgages, could provide diversified revenue growth, supporting overall earnings.
  
• Potential improvements in credit costs due to initiatives like issuing accelerated provisions and floating provisions for non-performing assets are expected to stabilize and lower overall credit risks, supporting better margins and profitability.

Ujjivan Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Ujjivan Small Finance Bank's revenue will grow by 19.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 24.6% today to 20.9% in 3 years time.
• Analysts expect earnings to reach ₹14.1 billion (and earnings per share of ₹7.31) by about May 2028, up from ₹9.7 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting ₹16.1 billion in earnings, and the most bearish expecting ₹10.8 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 8.8x on those 2028 earnings, up from 8.5x today. This future PE is lower than the current PE for the IN Banks industry at 10.7x.
• Analysts expect the number of shares outstanding to decline by 0.98% 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.

Ujjivan Small Finance Bank Future Earnings Per Share Growth

Risks

• The bank's net interest margin (NIM) experienced a decline to 8.8% for FY '25, down from 9.05% the previous year, primarily due to an asset mix shift towards secured loans, which could continue to pressure future earnings as the transition progresses.
  
• Elevated operating expenses were noted, with significant increases driven by investments in business expansion, new alliances, and technology, raising concerns about potential net margin impacts if revenue growth does not offset these costs.
  
• The bank's credit cost for FY '25 was notably high at 2.45% of average gross advances, reflecting ongoing credit risk challenges that could adversely impact net earnings if not controlled.
  
• The introduction of new Guardrail 2.0 guidelines by MFIN and potential geographical-specific issues may continue to exert pressure on the micro banking segment, posing risks to revenue stability from this traditionally core area.
  
• While striving to diversify its loan portfolio, Ujjivan's ability to maintain revenue growth and asset quality amidst increasing exposure to newer loan segments like vehicle finance and agri banking, which have shown high growth rates, remains uncertain.

Valuation

• The analysts have a consensus price target of ₹44.357 for Ujjivan 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 ₹59.0, and the most bearish reporting a price target of just ₹36.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹67.4 billion, earnings will come to ₹14.1 billion, and it would be trading on a PE ratio of 8.8x, assuming you use a discount rate of 14.0%.
  
• Given the current share price of ₹42.63, the analyst price target of ₹44.36 is 3.9% higher. 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.