Stock Fundamentals

Should you buy AU Small Finance Bank despite premium valuation?

Radhika Merwin | Updated on January 12, 2020 Published on January 11, 2020

The rally in broader indices last year, though pleasantly surprised market and investors, was a narrow one, led by a handful of large-cap stocks. A few other fundamentally strong and resilient companies also saw their stock prices gain as investors, drawing comfort from good earnings visibility, flocked to those firms. While many of these stocks trade at historically high valuations, some of them still offer good buying opportunity from a long-term perspective, notwithstanding possible volatility in the near-term amid growing domestic growth challenges and geopolitical tensions.

AU Small Finance Bank, which came out with its IPO in mid-2017, has had a good run since its listing, thanks to strong growth in loans, improvement in operational efficiency, good asset quality and healthy return ratios.

While the stock trades at a premium valuation — about 4.8 times its one-year forward book — it still remains a good bet for the long run. Investors can accumulate the stock in declines.

Healthy performance

AU Small Finance Bank operates in mainly three business lines — vehicle finance; micro, small and medium enterprises loans (SBL-MSME); and small and medium enterprises loans (SMC assets).




Within vehicle finance, while 64 per cent pertains to new vehicles, 21 per cent is used-vehicle financing, which has helped cushion the pain in the underlying auto segment. Overall retail, which includes vehicle (41 per cent) and SBL-MSME (34 per cent) loans contribute about 79 per cent to the company’s total assets under management (AUM). Home, gold, personal and consumer-durable loans also form part of retail assets, but are yet to gain scale.

The bank’s lending to NBFCs, real estate, business banking and agri-SME forms part of its SMC assets, which contribute about 19 per cent to the total AUM. In the first half of FY20, the bank reported a strong 38 per cent growth in AUM, led by a 44 per cent growth in retail AUM.

While the new vehicle segment grew 20 per cent y-o-y, used vehicle grew by a higher 64 per cent and SBL-MSME also saw strong traction, growing 53 per cent. Disbursements in the first half of FY20 grew 25 per cent, led by used vehicles, MSME, business banking and agri SME. The management expects disbursements to pick up further in the second half.




The company’s overall yields (AUM IRR) has inched up in the September quarter, and this, coupled with a fall in cost of funds, has resulted in an improvement in spreads to 6.9 per cent from 6.6 per cent in the June quarter.

The bank has been focussing on bringing down the overall cost of funds by reducing its reliance on certificates of deposits and repaying some of its high-cost borrowings. The rest of the high-cost borrowings is expected to be repaid in the coming quarters, which is expected to aid spreads.

While the share of CASA (current account and savings account) has been trending lower, the share of retail term deposits has been inching up. The bank has also seen a decline in cost-to- income ratio — to 56.6 per cent in the first half of FY20 from 60.7 per cent last fiscal — on the back of improving operational efficiencies.

Asset quality

AU Small Finance Bank has been able to maintain its asset quality thus far, despite robust growth in its AUM. As of September 2019, the bank’s GNPA (gross non-performing assets) stood at 2 per cent of loans. The bank improved its provision coverage in the September quarter to 44 per cent from 40 per cent in the June quarter (utilising the tax cut gains).

The bank has increased its standard asset provisioning for NBFCs to 1 per cent from mandated level of 0.4 per cent.

NBFCs constitute about 9 per cent of the bank’s total AUM.

While about 50 per cent of the NBFC portfolio is BBB and below rated, the management expects asset quality to be steady, given that the portfolio is seasoned and well-diversified. In its real-estate book, which forms about 3 per cent of its total AUM, the bank has stopped disbursements in its builder LAP (loan against property) portfolio for the past eight quarters — GNPA ratio for the builder LAP portfolio stood at 7.8 per cent in the September quarter.

While asset quality risk has been kept at bay so far, given the bank’s exposure to NBFC/real estate, it may need some monitoring. Also, scaling up retail deposits will be imperative to sustain profitability. AU Small Finance Bank still has its operations concentrated in Rajasthan, Gujarat, Maharashtra and Madhya Pradesh, though it has expanded its business into other geographies. Rajasthan still constitutes 41 per cent of the overall loan AUM. However the growth trajectory outside of Rajasthan is healthy — non-Rajasthan disbursements grew 49 per cent in the first half of FY20 vis-à-vis 38 per cent in Rajasthan.

Strong capital ratios with tier 1 at 14.9 per cent as of September (has 6.4 per cent stake in Aavas Financiers as of September worth about ₹970 crore in market valuation) and return ratios (RoE at 17.5 per cent) will drive premium valuations.

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Published on January 11, 2020
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