I-Sec upgrades AU Small Finance Bank to buy; raises target price to Rs 725

ICICI Securities has upgraded AU Small Finance Bank to BUY (from Hold earlier) with a revised target price of Rs 725 (Rs 625 earlier). The current market price of Au Small Finance Bank Ltd. is Rs 557.1 .

Financials
Key segments adversely impacted AU SFB?s credit cost trajectory during the past nine months are MFI and CC. Credit cost in the MFI segment stood at 5.4%for 9MFY25 and 9.2% in the CC segment during H1FY25. While the two portfolios together contribute ~10% of gross advances, they impacted credit cost by ~50% during 9MFY25. During 9MFY25, portfolio credit cost stood at 1.5%, of which MFI contributed 40bps and CC/PL contributed 38bps while secured retail contributed 65bps to overall credit cost and commercial banking contributed 9bps.


With X-bucket CE reaching ~99% in Jan?25, 39% unique customer base and ~50% portfolio being sourced in FY25, we expect MFI stress to subside meaningfully by Q2FY26E. The same should help rein in MFI credit costs to normalised level of ~3%.

AU SFB entered the CC business during H1FY22 to enhance its product offering and use it as a key tool to accelerate and retain liability customer. However, its execution track record in scaling the CC portfolio has remained subpar so far with >9% credit cost, warranting a course correction. The AU SFB management acknowledged the challenges in CC business and initiated several measures to improve performance.

Investment Rationale
AU SFB?s profitability, post merger in Apr?24, was impacted due to elevated credit cost on the back of higher-than expected delinquencies in its credit card (CC)/microfinance (MFI) portfolios and NIM compression. While near-term challenges persist, we believe RoA at 1.5%, as on Dec?24, has bottomed out and shall witness a steady uptick Q1FY26E onwards. Key drivers for RoA expansion would be: 1) normalisation in MFI credit cost to ~3% (9MFY25 credit cost at 5.41%); 2) course correction in CC business to pare credit costs and align with industry average of 6?7%; and 3) a falling rate cycle auguring well for cyclical recovery in NIM (~64% of assets are fixed price). On balance, ICICI Securities expects RoA improving ~30bps to 1.8% by FY27E.

With likely improvement in profitability and the recent stock price correction (~15% in past 1-3 months), ICICI Securities upgraded the stock to BUY (Hold earlier) with a revised target price of Rs 725 (earlier Rs 625), based on ~3x Sep?25E BVPS (earlier: 2.5x). The stock is currently trading at 2x/1.7x FY26E/FY27E BVPS.