Capital infusion, change in borrowing mix key triggers for AU Small Finance

Margins likely to come under pressure as bank will pass on benefits to borrowers, say analysts

The stock of AU Small Finance Bank (AU SFB) has surged about 20 per cent in the last six months, outperforming the BSE Bankex’s return of 8.4 per cent. The stock continues to trade at a premium valuation of over five times its FY20 estimated book value. Demand for the stock is on account of strong performance and robust earnings outlook, with recent triggers being the capital infusion and a change in its borrowing mix.

Temasek Holdings invested ~10 billion in the bank (30 per cent equity and 70 per cent convertible warrants) in May this year, and AU SFB also changed its borrowing mix. While the share of nonconvertible debentures came down from 46.2 per cent a year ago to 14.3 per cent now, the share of term loans was down from 13.2 per cent to 1.9 per cent. In the March quarter, the share of the two instruments was at 19.5 per cent and 4.9 per cent, respectively. Share of deposits also increased to 59.3 per cent in the June quarter, from just 9.9 per cent a year ago and 50.9 per cent in March.

Though the change in funding mix will reduce the cost of funds, the same is unlikely to reflect in improvement of profitability as the bank would pass on these benefits to its borrowers.

“The bank is in the process of transforming itself into a full-fledge bank. Given the rising competitive intensity AU SFB should see some pressure on margin in FY19,” says Ankit Choudhary, analyst at Equirus. Even in the June quarter, owing to a 180 basis point year-on-year fall in yields (return on average interest-earning assets/advances) and higher liquid assets, AU SFB’s net interest margin (NIM) contracted 130 basis points to 5.8 per cent.

However, lower operating expenses, pause in branch expansion, and a rise in noncore income through sale of priority sector lending certificates (PSLC) should support the bottom line in FY19. In Q1, AU SFB earned ~433 million from PSLCs, which is expected to continue going ahead. The management targets 6 per cent NIM in FY19 versus 6.6 per cent in FY18, and 35-40 per cent growth in its loan book in the current fiscal year.

In the medium term, AU SFB's overall earnings are expected to grow on the back of loan book improvement. The capital infusion should enable the bank to leverage the growth opportunity. Within 18 months, 75 per cent (~5.25 billion) of the convertible warrants will be invested.

Therefore, considering a high valuation, any correction in the stock price will be a good entry point for longterm investors.