AU Small Finance Bank (AU), in its eleven quarters as SFB, has exhibited excellent execution on most business metrics. This includes diversification of asset mix with consistent launch of new products; rollout of a robust digital platform with many first-in-industry and best-in-class banking initiatives such as WhatsApp account opening, minimal paperwork with no deposit or withdrawal slips, branch-agnostic account opening, etc; early verticalisation of businesses considering the pace of balance sheet expansion; tight control over operating expenses even during transition phase (FY17-19) and superior asset quality, especially in the current challenging environment without compromising on the growth momentum. AU’s industry-leading AuM growth (37% y-o-y) in Q3FY20 and pristine asset quality, amid macro headwinds, vindicates the management’s execution capabilities and the bank’s resilient business model. We upgrade to ‘add’ (earlier ‘hold’) with a revised TP of Rs 1,330 (earlier Rs 980) as we increase our target multiple to 6.5x to reflect management’s excellent execution of SFB strategy.

AU has remained on the forefront in timely launch of products with best-in- class productivity. In its last 11 quarters journey as an SFB, AU’s key differentiator has been its product innovation. It has added multiple products in retail over the past 2.5 years. It has remained focused on its core strength and philosophy of sticking to ‘secured assets’ as reflected in the share of secured loans (highest among peers) in its loan book. While AU has remained the leader in product launches, its productivity also remained best-in-class with retail asset per branch at Rs 310 mn vs ~Rs 210 mn for Equitas/ Ujjivan. Given AU’s meaningful liability customer base of 2,500 per branch vs ~1,325/1,250 for Equitas/Ujjivan and timely rollout of retail asset products, we feel it would be able to increase product per customer in the times to come.

Superior retail liability franchise built by ‘simplifying banking’ as reflected in ~45bps lower cost of funds vs peers. Launch of ‘AU Royale’ has further strengthened AU’s positioning in metros. A key differentiator of AU SFB is its ability to think beyond traditional banking and build customer-friendly processes such as WhatsApp account opening, minimal paperwork with no deposit slips or withdrawal slips, branch-agnostic account opening, etc. This has helped AU build one of the best retail liability franchises vs other SFBs.

Notably, AU’s cost of funds at 7.6% is~40/50bps lower than Equitas/Ujjivan’s, which validates our confidence in AU’s ability to attract customers via its differentiated approach to banking. Also, it recently launched ‘AU Royale’, its flagship premium lifestyle programme to target UHNIs, which we believe will further strengthen AU’s position in metro/urban markets.

Future-ready. Despite being a relatively younger organisation than KMB/IIB, select operating and productivity metrics for AU is better than peers. Importantly, even with higher cost and lower CASA, AU’s profitability is highest when compared to new private sector banks. Higher margins and fee income coupled with relatively lower credit cost is helping AU generate best-in-class return ratios. When we look at Indian lending businesses, including NBFCs, banks, HFCs etc, entities wh have maintained granularity and remained focused on asset quality have outperformed broader industry in terms of profitability. While being “granular” is a key to success, very few entities have successfully built such franchise in the recent past. AU clearly stands out, as since its inspection, it has always remained focused on building “granular” business. Our exit multiple of 6.5x is a reflection of sustainability of industry-leading growth amid macro headwinds, pristine asset quality, successful execution of SFB strategy, and most importantly, readiness to become a universal bank.