Shift To Secured Lending And Digital Expansion Will Improve Asset Quality And Customer Retention

Key Takeaways

• Diversifying the loan portfolio towards secured lending and new segments is expected to improve asset quality and drive loan book growth.
  
• Enhanced digital offerings and improved collection efficiency could boost customer retention, reduce credit costs, and support revenue growth.
  
• Rising slippages and a shift to secured loans could pressure net interest margins and asset quality, impacting future profitability.

Catalysts

Provides various banking and financial services in India.

• The strategy to diversify the loan portfolio towards a more secured book is expected to impact future growth positively, potentially reducing credit risk and improving asset quality. This shift aims to enhance overall earnings stability.
  
• Efforts to improve collection efficiency and signs of reduced stress in key states could lead to better asset quality and lower credit costs, potentially resulting in improved net margins.
  
• The reduction in interest rates for group and individual loans, combined with maintaining stable funding costs, is likely to attract quality borrowers, which could offset yield impacts and support revenue growth through increased disbursements of high-yielding products.
  
• Expanded digital offerings and enhancements in customer service capabilities are likely to increase customer retention and acquisition, potentially leading to higher revenue from both interest income and fees.
  
• The ongoing transition towards secured lending and investments in new segments like affordable housing and vehicle finance are expected to drive significant loan book growth, potentially enhancing revenue streams and contributing to increased earnings in the future.

Ujjivan Small Finance Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Ujjivan Small Finance Bank's revenue will grow by 19.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 24.6% today to 20.5% in 3 years time.
• Analysts expect earnings to reach ₹14.0 billion (and earnings per share of ₹7.34) by about March 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 9.0x on those 2028 earnings, up from 7.1x 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 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 14.62%, as per the Simply Wall St company report.

Ujjivan Small Finance Bank Future Earnings Per Share Growth

Risks

• The bank reduced interest rates in group loans and individual loans, which could impact its future net interest margins and profitability if offsetting growth in higher-yielding products does not materialize as expected.
  
• Slippages from group loans and individual loans increased significantly, which could lead to higher credit costs and affect net margins negatively if not controlled.
  
• Despite improvements in collection efficiency, there remains a risk of rising PAR levels in certain states, potentially affecting the bank's asset quality and leading to increased provisioning costs.
  
• The transition to the 3-lender cap could lead to difficulties in retaining customers and potential revenue loss if significant number of existing borrowers choose other lenders or fail to consolidate loans with Ujjivan.
  
• Increasing focus on secured loans may lead to long-term compression in net interest margins due to their inherently lower yields compared to unsecured microfinance loans.

Valuation

• The analysts have a consensus price target of ₹44.5 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 ₹68.2 billion, earnings will come to ₹14.0 billion, and it would be trading on a PE ratio of 9.0x, assuming you use a discount rate of 14.6%.
• Given the current share price of ₹35.61, the analyst price target of ₹44.5 is 20.0% 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.