Equitas Small Finance Bank earnings beat supports profitability recovery despite NIM pressure

Investment View and Valuation

Motilal Oswal Financial Services retained its BUY recommendation on Equitas Small Finance Bank after a steady Q1 FY27 performance. The broker said the quarter was supported by healthy other income and controlled provisions, although net interest margin contracted because of higher funding costs.

Motilal Oswal raised its FY27 and FY28 earnings estimates by 10% and 7%, respectively. It values the bank at 1.4 times FY28E adjusted book value per share to derive a target price of Rs 90.

Q1 FY27 Financial Performance

Equitas Small Finance Bank reported Q1 FY27 profit after tax of Rs 1.8 billion, a 16% beat versus Motilal Oswal's estimate. Net interest income grew 31% year on year and 5% quarter on quarter to Rs 10.3 billion, broadly in line with estimates.

Other income declined 12% year on year and 3% quarter on quarter, but was 6% above the broker's estimate. Treasury income was Rs 310 million. Operating expenses were in line with expectations, while lower provisions helped pre-provision operating profit reach Rs 3.7 billion.

Margins and Profitability Outlook

Margin was the principal pressure point in the quarter. Q1 FY27 NIM declined 12 basis points quarter on quarter to 7.24% as cost of funds rose 11 basis points to 7.05%, following increases in savings-account and term-deposit rates. This occurred despite a 23-basis-point improvement in yield on gross advances.

The CASA ratio declined 108 basis points quarter on quarter to 25.1%, which Motilal Oswal identifies as a potential continuing pressure on margins. Management expects the cost of funds to have peaked and forecasts NIM of about 7.1% over the next two to three quarters and for the full year.

Management also expects operating-expense moderation in coming quarters, which could improve return on assets. It retained FY27 return on assets guidance of 1.2%, with exit return on assets of about 1.5%, and indicated that guidance could be revised upwards in the next quarter. Motilal Oswal forecasts FY27E return on assets and return on equity of 1.2% and 12.2%, respectively.

Business Growth and Deposits

Business growth remained healthy. Net advances increased 28.8% year on year and 4.6% quarter on quarter to Rs 447 billion, while AUM grew 26.7% year on year to Rs 476 billion. Growth was led by MFI, vehicle finance, small business loans and home loans.

• MFI, including direct assignment, grew 4.6% quarter on quarter.
• Home finance grew 4.5% quarter on quarter.
• Vehicle finance grew 15% year on year and 3% quarter on quarter, aided by 6.7% quarterly growth in used-car loans.
• New commercial-vehicle loans declined 2% quarter on quarter and 15% year on year.

Deposits grew 10.4% year on year and 5.2% quarter on quarter. Management guided for loan growth of about 20% year on year and expects to maintain the credit-deposit ratio near current levels.

Asset Quality and Key Risks

Asset quality improved, with GNPA and NNPA ratios declining 19 basis points and 1 basis point quarter on quarter to 2.42% and 0.71%, respectively. The provision coverage ratio fell to 71.0%.

Management expects credit costs to remain broadly stable and said no stress has emerged from geopolitical developments. However, the bank remains cautious about higher fuel costs because of its standard-asset provision in the MFI segment.