Equity Research

Equity Research INDIA June 22, 2018 BSE Sensex: 35432 AU Small Finance Bank BUY ICICI Securities Limited Upgrade from Hold is the author and distributor of this report Because tomorrow came yesterday Rs690 Reason for Report: Company update and recommendation change FINANCIALS AU Small Finance Bank (AU’s) disbursement velocity in Q4FY18 left even our most optimistic expectations completely in the dust. In three months they disbursed about a quarter of their current loan AUM, an event one might legitimately expect in only a start-up! As if on cue, a primary raise - ~5% dilution, Target price Rs835 70% of it in warrants, @Rs692.8 per share – followed. A quick analysis of the composition of this growth spurt soothes nerves regarding the quality of said growth – the natural first order of business. Our March, 2018 initiating coverage Earnings revision report on the company mentioned, “…With leverage touching 8x in FY20E and (%) FY19E FY20E RoE expected to inch close to 20%, a capital raise maybe opportune…”. Short NII ↑ 3.2 ↑ 6.4 PPoP ↑ 5.2 ↑ 8.9 story shorter, in the next two months, AU reset the outer limits of what we PAT ↑ 7.8 ↑ 10.4 thought of as possible growth and raised equity capital. If we were nit picking, we could say that AU probably lost some pricing power in the bargain, at the Target price revision aggregate loan portfolio level, through an asset mix shift accommodating Rs835 from Rs700 traditional bank assets & customers. Most would however see it as a natural evolution in lieu of accelerated liability side gains since bank conversion. On Shareholding pattern balance, we would have to agree. Sep Dec Mar ‘17 ‘17 ‘18 We argue in the following pages, with segment granularity, that meaningful Promoters 32.9 32.7 32.7 outperformance of already high growth expectations is not implausible. Our bull- Institutional investors 16.6 18.9 19.2 case scenario analysis on next two years loan growth suggests that if said MFs and UTI 7.4 7.1 7.4 positive surprise does indeed play out; the bank may be in a position to access FIs/Banks 0.0 0.0 0.0 the equity markets, without prejudice to interim capital productivity, as early as Insurance co. 2.8 4.5 4.4 FIIs 6.4 7.3 7.4 H2FY20 (still!). A 3-5% dilution, even at a 27% discount to current valuation Others 50.3 48.4 48.1 multiples, would imply a 15-24% expansion in FY20E BVPS. This and the likelihood of many such shareholder value enhancing dilutions in its wake, supports current valuations of 6.8xFY19E P/BVPS. Hiccups on asset quality can Price chart derail the story, but the remoteness of that possibility is well captured in the 750 valuations. We continue to nominate the real estate cycle sensitive subset of the SME segment as the most likely culprit of an unlikely upset. We drop our target 700 multiple to 6xFY20E BVPS from 7x, to reflect the conclusion of the equity raise 650 which had motivated our earlier increase. This leads to a 12M TP of Rs835 (Rs (Rs) 600 700 earlier, upgrade is due to the current dilution’s boost to FY20E BVPS). We upgrade our recommendation to BUY from HOLD. 550 Growth not at the cost of safety. A closer look at the composition of the growth in 500 disbursements delivered by the company provides succour on any worries about dilution of credit standards. Simply put, the high growth was due to the company Jul-17 Jun-18 Mar-18 Sep-17 Dec-17 capitalising on its liability side gains to access customers at lower loan yields, who they would not have been able to target as a NBFC. This is part of the reason of the high growth (25.1% YoY) in auto disbursements and the jump in business banking loans (traditionally a bank product). These two segments were the main drivers of the growth surprise as MSME growth expectations were already high. Market Cap Rs197bn/US$2.9bn Year to March 2018 2019E 2020E 2021E Reuters/Bloomberg AUFI.BO/AUBANK IN NII (Rs mn) 9,389 12,928 16,618 22,138 Shares Outstanding (mn) 285.7 Net Profit (Rs mn) 2,900 3,960 6,634 9,534 Research Analysts: 52-week Range (Rs) 737/358 EPS (Rs) 9.9 12.9 21.7 31.1 Santanu Chakrabarti Free Float (%) 67.3 % Chg YoY -65.6 30.1 67.5 43.7 [email protected] FII (%) 7.4 P/E (x) 69.4 53.4 31.9 22.2 +91 22 6637 7351 Daily Volume (US$/'000) 2,043 P/BV (x) 8.8 6.8 5.0 4.1 Abhijit Tibrewal Absolute Return 3m (%) [email protected] 18.1 Net NPA (%) 1.3 1.8 1.8 1.8 +91 22 6637 7230 Absolute Return 12m (%) NA Dividend Yield (%) 0.1 0 0 0 Sensex Return 3m (%) 7.4 RoA (%) 2.9 2.2 2.6 2.9 Sensex Return 12m (%) 14.7 RoE (%) 13.6 14.7 18.0 20.3 Please refer to important disclosures at the end of this report AU Small Finance Bank, June 22, 2018 ICICI Securities Growth not at the cost of safety A diagnostic analysis of AU Small Finance Bank’s growth in Q4FY18 is illustrative of the fact that growth has been a function of a target market expansion from the ability to tackle lower yield customer segments (namely, the scale up in business banking, usual high growth in MSME financing and a market expansion opportunity in auto finance), thanks to liability side gains. Chart 1: Auto and MSME leads disbursement run rate expansion… Vehicle Finance MSME SME Gold Loan and others 30,000 28,360 990 25,000 10,600 20,000 20,980 1,990 15,000 6,420 (Rs mn) (Rs 10,000 16,260 5,000 10,150 0 Q4FY17 Q4FY18 Source: Company data, I-Sec research Chart 2: …as does business banking and NBFC, together constituting the lion’s share of the dramatic disbursement jump NBFC Real Estate Business Banking 16,000 13,690 14,000 12,000 5,650 10,000 8,000 1,650 (Rs mn) (Rs 6,000 3,620 4,000 410 790 6,390 2,000 2,420 0 Q4FY17 Q4FY18 Source: Company data, I-Sec research 2 AU Small Finance Bank, June 22, 2018 ICICI Securities Chart 3: Move into business banking signals openness to traditional banking low risk reasonable yield asset classes Business Banking disbursements QoQ Growth rate (RHS) 6,000 5,650 250 5,000 200 4,000 150 3,000 (%) (Rs mn)(Rs 100 2,000 1,690 1,440 50 1,000 90 280 410 0 0 0 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Source: Company data, I-Sec research Chart 4: Auto finance growth also helped by willingness to accept business at more bank equivalent yields Vehicle Finance disbursements QoQ Growth rate (RHS) 18,000 16,260 70 16,000 60 50 14,000 40 12,000 10,750 10,150 10,560 30 10,000 8,600 8,330 20 6,780 8,000 10 (%) (Rs mn) (Rs 0 6,000 (10) 4,000 (20) 2,000 (30) 0 (40) Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Source: Company data, I-Sec research Chart 5: MSME business continues to grow from a still small base MSME disbursements QoQ Growth rate (RHS) 12,000 200 10,600 10,000 150 8,000 100 6,420 6,200 5,890 6,000 50 4,240 (%) 4,590 (Rs mn)(Rs 4,000 0 2,370 2,000 (50) 0 (100) Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Source: Company data, I-Sec research 3 AU Small Finance Bank, June 22, 2018 ICICI Securities Growth acceleration can foreshorten dilution timeline We consider a scenario where growth surprises further to the north of the 35.1% CAGR that we build in for FY18-20E. We do not believe that this scenario is beyond the pale, given that our base case growth assumptions are not factoring in; (i) rebuild of the housing loan business segment, (ii) a likely acceleration in the UV/ CV cycle, (iii) the opportunity to grow business banking at a high clip and (iv) off balance sheet business growth through products like bank guarantees. Our bull case scenario indicates the opportunity for a late FY20 dilution. It does not build one in. Chart 6: Vehicle finance disbursements can be legitimately higher than our expectations and forms one of our two segmental tweaks for the bull case Vehicle Finance Disbursements 30,000 Base Case Bull Case 25,000 20,000 15,000 (Rs mn)(Rs 10,000 5,000 0 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Source: Company data, I-Sec research Chart 7: SME segment disbursement assumptions for the bull case higher to accommodate a strong showing in the re-started housing loan segment SME Disbursements 4,000 Base Case Bull Case 3,500 3,000 2,500 2,000 (Rs mn) (Rs 1,500 1,000 500 0 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Source: Company data, I-Sec research 4 AU Small Finance Bank, June 22, 2018 ICICI Securities Chart 8: Just changing the assumptions on these two segments boosts total FY19E AUM growth by 810bps in the bull case AUM Growth (FY19E) Base case Bull case 200 180 174.0 160 140 120 100 78.6 84.7 (%) 80 49.2 48.3 60 40.3 40.2 32.5 34.0 40 20 7.8 0 -20 -5.4 Vehicle MSME SME Gold Loan NBFC Real Business Total AUM Finance and others Estate Banking Source: Company data, I-Sec research Chart 9: A capital raise becomes justifiable by mid to late FY20 (earlier leverage looks higher because warrant conversion is assumed in Q2FY20) Leverage (Loans/Net Worth) 9.0 Base Case Bull Case 8.0 7.4 7.6 7.4 7.1 7.2 6.7 6.9 6.9 7.0 6.2 6.5 6.3 6.4 5.7 5.9 6.0 5.3 5.4 5.0 (x) 4.0 3.0 2.0 1.0 0.0 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Source: Company data, I-Sec research Chart 10: Hard to make the case that a late FY20 dilution in the bull case, happens at a point of low capital productivity ROE Base Case Bull Case 25.0 20.6 19.8 20.0 18.7 18.9 17.4 17.3 18.0 15.7 16.2 16.1 15.0 14.0 14.1 13.9 14.6 11.1 10.9 (%) 10.0 5.0 0.0 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Source: Company data, I-Sec research 5 AU Small Finance Bank, June 22, 2018 ICICI Securities Chart 11: Of course, BVPS does not shift by much in the absence of a dilution Base case Bull case 150 141.8 139.3 140 130 120 (Rs) 110 102.0 102.3 100 90 80 FY19 FY20 Source: Company data, I-Sec research Chart 12: EPS sensitivity is obviously higher Base case Bull case 26 23.8 24 21.7 22 20 18 (Rs) 16 13.5 13.9 14 12 10 FY19 FY20 Source: Company data, I-Sec research 6 AU Small Finance Bank, June 22, 2018 ICICI Securities A triggered dilution can boost BVPS substantially If the bull case growth scenario triggers a dilution in early FY20E, the following analysis illustrates the impact on FY20E BVPS for a 3% and 5% dilution.

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