MOSL: AU SMALL FINANCE BANK (Upgrade to Buy)-Perfect start to a promising journey

AU Small Finance Bank: Perfect start to a promising journey; Upgrading to Buy

(AUBANK IN, Mkt Cap USD3.1b, CMP INR587, TP INR705, 21% Upside, Upgrade to Buy)

AU Small Finance Bank (AUBANK) has reported strong progress as it undertakes transitioning from a leading retail-focused NBFC (AU Finance) to a small finance bank (SFB). While migration to an SFB is expected to weigh on the return ratios over the near term, we believe operating costs should peak out in FY18E and will begin to gradually improve thereafter. The bank continues to record robust balance sheet growth and has also surprised positively in terms of liability franchise development (2.7x CD ratio, 37% CASA ratio within three quarters of banking operations), which should provide cushion against a decline in yields. We expect 42% earnings CAGR over FY18-20E, driving RoA/RoE to 1.98%/20.1% in FY20E. Post the recent correction, the stock trades at 4.9x FY20E BV and 27x FY20E EPS. In view of its long-term sustainable business and earnings growth potential, we believe that AUBANK should continue trading at a premium. We thus upgrade the stock to Buy with a target price of INR705 (unchanged), based on 5.9x FY20E BV/32.7x FY20E EPS.

Business growth remains robust; diversification set to improve further

Post transition to an SFB, AUBANK has launched several new deposit/lending products and also expanded its presence in chosen geographies. Business growth, too, continues to be strong (67% YoY loan growth; 38% YoY AUM growth). Aided by its strong distribution network and launch of new products (including housing finance), AUBANK should deliver 42% loan book CAGR over FY18-20E in our view. We believe loan mix and geographical diversification will add stability to the franchise and help maintain steady growth.