MOSL: AU SMALL FINANCE BANK (INITIATING COVERAGE)-First among equals

​AU SMALL FINANCE BANK (INITIATING COVERAGE): First among equals

(AUBANK IN, Mkt Cap USD3.1b, INR697, TP INR705, 1% Upside, Neutral)

AU Small Finance Bank (AUBANK) has emerged from the transition of a leading retail-focused NBFC (AU Finance) to a bank. It primarily serves low and middle-income individuals/businesses, with distinct focus on three key lending products – Vehicle finance, MSME finance, and SME finance. During FY13-17, AU delivered 36% loan book CAGR and 46% earnings CAGR. With the grant of a Small Finance Bank (SFB) license AUBANK plans to rapidly expand the scale of its operations and has shown strong progress in building its deposit franchise in the early days of its SFB launch. The migration to an SFB will weigh on return ratios in the near term; however, we believe significant under-penetration in the states where AUBANK operates, strong credit underwriting, and rapid scale-up of new product launches will enable it to emerge as a leading SFB over the long term. We expect 42% earnings CAGR over FY18-20e, driving FY20e RoA/RoE to 1.94%/20.1%. While we appreciate the long term opportunity that AUBANK presents we believe that the stock is fairly valued at current valuations (~96% gain over the IPO price). We thus initiate coverage with a Neutral rating and TP of INR705 (5.9x Mar-20E BV, 32.1x FY20E EPS).

Business growth to remain robust; diversity set to improve further

As an asset-financing NBFC, AUBANK built a strong presence across three secured lending segments - Vehicle loans, MSME loans, and SME loans. On transitioning to an SFB, it has launched several new deposit and lending products and has also expanded into newer geographies -

• AUBANK had successfully launched and built a housing finance business over FY11-16, which it later sold at ~5x P/B. AUBANK now plans to launch its home loan product by 1QFY19e with focus on affordable housing segment. Given its prior experience in housing finance and its strong presence in tier-II/III centers, we believe AUBANK is well placed to rapidly scale up this business post launch.
  
• We expect AUBANK to deliver 42% loan CAGR over FY18-20e. The diversity in loan mix and geographic regions will also add stability to the franchise.