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AU Small Finance Bank (AUSFB) is poised for a strong earnings growth trajectory, with analysts projecting a 30% CAGR over FY24-27, despite near-term asset quality challenges. The bank is implementing strategies to balance rising credit costs with improve0d operational efficiency, aiming to strengthen profitability over the long term.
AUSFB’s asset quality has been under pressure, with elevated slippages from both secured and unsecured portfolios. As of Q2FY25, the Gross NPA ratio stood at 1.98%, up from 1.78% QoQ, while the Net NPA ratio rose to 0.75%. The bank has tightened underwriting norms and ramped up collection efforts to mitigate further deterioration. However, credit costs are expected to remain elevated in the second half of FY25 due to continued stress in the unsecured segments, particularly in microfinance and credit cards.
Despite challenges in unsecured lending, management remains optimistic about credit cost recovery in the secured business during H2FY25, with a focus on curbing overall credit costs for FY25 to levels similar to H1FY25, with a variance of 5-10 basis points. The bank is targeting a return on assets (RoA) of 1.6% for FY25, with ambitions to scale this to 1.8% by FY27 as asset quality stabilizes.
Margin strength and cost control
Contrary to expectations of margin compression, AUSFB posted stronger-than-expected margins in Q2FY25, with NIMs improving to 6.1%. The bank’s management expects NIMs to remain stable at around 6% for FY25, supported by lending yields holding up across segments like vehicle loans, home loans, and gold loans. Additionally, cost of funds (CoF) is expected to settle lower at 7.1-7.15%, down from previous estimates of 7.2-7.25%.
Fee income growth continues to gain momentum, while AUSFB’s cost-to-income (C-I) ratio is projected to improve to 60% in FY25, driven by efficiency gains from employee productivity and branch profitability. These improvements, alongside steady margins and operational leverage, are expected to help offset the impact of elevated credit costs, thereby supporting the bank’s profitability targets.
AUSFB is committed to scaling its RoA to 1.8% by FY27, driven by improving cost ratios and gradually stabilizing credit costs. The bank’s management remains focused on high-margin segments while calibrating growth in high-risk unsecured portfolios. Axis Securities and Elara Securities both underscore AUSFB’s potential for a robust balance sheet, with steady NIMs and cost control measures providing a buffer against near-term asset quality concerns.
Valuation and outlook
Both Axis and Elara maintain a positive outlook on AUSFB, retaining a “BUY” recommendation with a target price of Rs 800 per share. The bank’s valuation remains at 2.9x September 2026 estimated book value, reflecting confidence in its ability to navigate current challenges while delivering strong growth.
In the longer term, AUSFB is expected to achieve RoA/RoE of 1.7-1.8%/16-18% over FY26-27, positioning it well for continued earnings growth and operational improvement.
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