AU Small Finance Bank

In a tale of two markets, India's banking sector emerges as a beacon of bullish sentiment, even as other sectors face slight headwinds. With the RBI's strategic rate cuts and major players like HDFC and ICICI delivering stellar results, the Bank Nifty is soaring. But what about the smaller, yet ambitious players? This article dives into the dynamic world of AU Small Finance Bank, a rising star leveraging strategic mergers, digital innovation, and a cleareyed vision to carve out its own success story. Is AUBANK the smart investment you've been looking for? Read on to find out [EasyDNNnews:PaidContentStart]

The Indian stock market is currently witnessing a fascinating divergence, with frontline banking stocks charting a distinct upward trajectory while other sectors grapple with ups and downs. This bullish sentiment surrounding the banking space is fuelled by a confluence of factors, painting a compelling picture for investors keen on understanding the undercurrents of the Indian economy. At the heart of this optimism lies the Reserve Bank of India's (RBI) recent Monetary Policy Committee (MPC) decision to implement a 50 basis points (BPS) repo rate cut, bringing the repo rate down to 6 per cent. This move has ignited a sharp upmove in NBFCs and banking stocks as the market anticipates increased borrowing activity and consequently, stronger future earnings for NBFCs and banks.

Adding further impetus to this positive outlook are the robust Q4 results for the fiscal year 2025 delivered by several banking majors, including HDFC Bank and ICICI Bank. These institutions have showcased better-than-expected performances, marked by lower slippages and encouraging growth in both deposits and loan portfolios. This stellar performance has propelled the Bank Nifty to a new all-time high, breaching the 55,000 mark and registering impressive gains in recent weeks and months. The surge underscores the market's confidence in the banking sector's profitability and growth potential.

The RBI's supportive stance is another critical element bolstering the banking sector. The central bank's shift from a neutral to an accommodative policy signals its commitment to fostering economic growth. This accommodative approach translates to a more favourable environment for industries that heavily rely on bank credit lines, indirectly benefiting the banking sector through increased lending opportunities and potentially improved asset quality. Furthermore, the RBI's strategic measures to enhance liquidity in the banking system, such as the reduction in the Cash Reserve Ratio (CRR), provide banks with more funds to deploy, further supporting lending activities.

While the banking sector basks in this favourable climate, other segments of the Indian economy are navigating through the challenging landscape, partly due to geopolitical tensions and earnings slowdown. This divergence highlights the relative strength and resilience of the banking and NBFCs sector, making it a focal point for investors seeking growth amidst broader economic uncertainties. Further, these developments in the banking sector have led us to delve deeper into the performance and prospects of AU Small Finance Bank, which has delivered strong Quarterly Results in Q4FY25, propelling the stock to gain more than 20 per cent in the past one month.

About the company
Established in 1996 as AU Financiers, a vehicle finance NBFC, AU Small Finance Bank (AUBANK), headquartered in Jaipur, transitioned into a scheduled commercial small finance bank in April 2017, subsequently listing on NSE and BSE. AUBANK strategically focuses on serving low and middle-income individuals and micro and small businesses, promoting financial inclusion through Personal, Premium, Business, and Government Banking segments, now including Microfinance post its merger with Fincare Small Finance Bank. With a pan-India presence encompassing 2,456 touchpoints and 677 ATMs across 21 States and 4 Union Territories, AUBANK serves over 1.1 crore customers. Its technology-driven approach is evident in its digital platform, AU 0101, boasting 33.3 lakh registered users and 15.4 lakh monthly active users. Revenue is generated through interest income and non-interest income across Treasury, Retail, Wholesale, and Other Banking operations.

AUBANK experienced significant growth through its merger with Fincare Small Finance Bank between October 2023 and April 2024, expanding its reach, especially in South India and microfinance. In September 2024, the bank applied for a Universal Banking License, signalling its ambition for broader operations and greater scale within the Indian financial market. These recent developments underscore AUBANK's dynamic evolution and its aspirations for continued growth in the banking sector.

Total Loan Portfolio
AU Small Finance Bank exhibits a well-diversified and predominantly retail-focused loan portfolio, reaching ₹1,15,704 crore in Q4FY25. The asset mix is heavily weighted towards Vehicle finance (31.7 per cent) and Mortgage-backed Loans (32.9 per cent). High RoA assets constituted 81 per cent of the disbursement mix as of Q4FY25, including Microfinance (5.8 per cent), EEFI (Emerging Enterprises & Financial Institutions Group – 3.6 per cent), and Gold Loans (1.6 per cent) A significant portion, around 63 per cent, of the portfolio is fixed rate, providing stability in a fluctuating interest rate environment.

Competitive Analysis
AU Small Finance Bank operates in a competitive Indian financial market, facing competition from a diverse range of players. Within the Small Finance Bank (SFB) segment, key competitors include Equitas Small Finance Bank, Ujjivan Small Finance Bank, Jana Small Finance Bank, Suryoday Small Finance Bank, Utkarsh Small Finance Bank, Capital Small Finance Bank, ESAF Small Finance Bank, Unity Small Finance Bank, Shivalik Small Finance Bank, and Northeast Small Finance Bank. Additionally, AUBANK competes with larger, well-established private sector banks such as HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank, IndusInd Bank, Yes Bank, and IDFC First Bank. The competitive intensity in the Indian banking sector is expected to remain high, particularly as AUBANK pursues its ambition of transitioning to a universal bank, which would further broaden its competitive sphere.

Growth Triggers
Strong Loan Book Growth: The bank has consistently demonstrated robust growth in its loan portfolio. In FY25, the Gross Loan Portfolio reached ₹1,15,704 crore, reflecting a healthy 20 per cent year-on-year growth.

Improving Asset Quality (Potential): While there have been recent concerns about elevated credit costs in unsecured lending, the bank has shown a historical ability to manage and improve asset quality. For instance, the gross NPA ratio improved sequentially in Q4FY25 from 2.31 per cent in Q3FY25 to 2.28 per cent. Moreover, the banks NPA has also come down from 0.91per cent in Q3FY25 to 0.74 per cent in Q4FY25. If the management's efforts to tighten underwriting and strengthen collections in the unsecured segments are successful, this could lead to lower credit costs and improved profitability, acting as a significant growth trigger.

Growth in Total Deposits and CASA: AU Small Finance Bank has been successful in growing its deposit base, with a 27 per cent year-on-year increase in total deposits in FY25. Furthermore, there's a focus on increasing the Current Account and Savings Account (CASA) deposits, which stood at 29.2 per cent in FY25. A higher CASA ratio lowers the cost of funds and improves net interest margins, contributing to profitability and growth.

Pan-India Branch Expansion: The bank has been strategically expanding its physical presence across India, exceeding 2,400 touchpoints. The merger with Fincare Small Finance Bank further expanded its network to 21 states and union territories. This expanding reach allows the bank to tap into new markets and customer segments, driving loan and deposit growth.

Q4FY25 – Financial performance
AU Small Finance Bank reported a robust Q4FY25, surpassing expectations with strong cost management and a significant 600 bps QoQ rise in provision coverage. The bank's Net Interest Income (NII) soared by 57 per cent YoY, reaching ₹8,012 crore for FY25 (a 55 per cent YoY increase). NIM stood at 5.8 per cent in Q4FY25, slightly down QoQ due to asset mix but improved to 5.9 per cent for FY25. Core income grew healthily by 23 per cent YoY in Q4 and 39 per cent YoY for FY25, driven by cross-selling initiatives. Operating efficiency improved, with the cost-to-income ratio falling to 55 per cent in Q4 and 57 per cent for FY25. Pre-Provision Operating Profit (PPOP) jumped by 99 per cent YoY in Q4 to ₹1,292 crore. The bank maintained a strong capital position with a CRAR of 20.1 per cent and a Tier-I ratio of 18.1 per cent. FY25 PAT saw a 32 per cent YoY increase to ₹2,106 crore, resulting in an RoA of 1.5 per cent. The bank has proposed a dividend of ₹1 per share.

Asset quality showed improvement with reduced slippages. AUBANK anticipates strong book value growth (18 per cent CAGR over FY25-FY27E) and an improved RoA of 1.85 per cent by FY27, supported by merger synergies and MFI recovery.

The bank aims for a Cost-to-Income (CTI) ratio below 55 per cent by FY27 and is increasing Credit Guarantee Fund for Micro Units (CGFMU) coverage in its Microfinance Institution (MFI) portfolio. Deposits and loan book grew by 11 per cent and 7.6 per cent QoQ, respectively. Awaiting a decision on its Universal Banking License application, AUBANK presents a positive outlook.

Valuation and Outlook
AU Small Finance Bank has demonstrated a strong financial performance in recent years, driven by growing deposits, improving loan book, and improving NIMs. The company has been growing its revenue at a three-year CAGR of 39 per cent and profit at a three-year CAGR of 23 per cent. The bank is currently trading at a price-to-book value of 3.00x, which is higher when compared with the industry price of 1.23x, suggesting a higher valuation. The outlook for AU Small Finance Bank appears promising, driven by strategic initiatives and a focus on sustainable growth. The merger with Fincare is expected to unlock significant synergies by expanding its reach, particularly in South India and the microfinance sector. The bank's pursuit of a Universal Banking License signals long-term ambitions for broader operations and improved deposit mobilization. While near-term credit costs in specific unsecured segments warrant monitoring, the medium-term target of achieving an RoA of 1.8 per cent by FY27 remains a key focus. AUBANK is strategically shifting its portfolio towards higher RoA assets and aims to increase the share of current accounts in total deposits. Efforts to enhance branch profitability and maintain a Cost-to-Income ratio below 60 per cent by FY27 are underway. The bank's commitment to digital transformation and expansion of its branch network further strengthens its position. Successful execution of its AU2027 strategy, coupled with a potential universal banking license, positions AUBANK for continued growth and improved profitability in the Indian financial market. Given the positive outlook of the banking sector and the growth of the bank, we give a BUY recommendation.

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