AU Small Finance Bank rating – Neutral: Recent exits highlight a larger issue

By: |
September 06, 2021 6:45 AM

Stretched valuations, asset quality concerns for street; but long-term story’s intact; ‘Neutral’ rating maintained

While mgmt tried to address these issues days ago, highlighting them to be largely re-location-related (Jaipur), we think this has not been an issue for other regional-focused lenders; hence, we do not take the explanation at face value as well.While mgmt tried to address these issues days ago, highlighting them to be largely re-location-related (Jaipur), we think this has not been an issue for other regional-focused lenders; hence, we do not take the explanation at face value as well.

AU has seen three exits in the past three months largely coming from the audit/risk departments, which has led to a steep fall in the stock. The 10-15% fall in the stock price (vs. NIFTY50 index up 2%) after the news of these exits clearly highlights a much larger concern than what the news suggests, in our view. While we understand that recent exits are largely business-as-usual (BAU) in nature, and we prefer not to dwell much into them, the stock price reaction clearly highlights concerns over stretched valuations and any potential asset quality risks, especially given the departments where these exits have happened.

We have highlighted recently some divergences in the asset quality trends which we find difficult to comprehend. While we remain positive on the long-term story of AU with strong growth trajectory, universal bank optionality and healthy book compounding, we find less comfort in the near-term outlook, especially with valuations at 24x/3.8x Sep-23F EPS/book providing less room for any disappointment; hence, we maintain our Neutral rating. We prefer Equitas (holdco; EQUITAS IN, Buy) over AU within the small finance banks (SFB) space.

Don’t read too much into recent exits in the near term…
AU has seen three top-level exits in the past three months with: (i) Nitin Gupta (chief internal audit officer) leaving in May-21; (ii) Alok Gupta, who joined in Mar-21, resigning; and (iii) Sumit Dhir (replacement of Nitin Gupta) resigning in less than five months. We highlight that AU has relatively much lower top-level exits vs. peer SFBs which have seen a much higher churn at business head levels as well. Hence, we think on a standalone basis this news is not a big negative. That said, exits in audit/risk departments do raise concerns around the transparency/quality of the book as well as risks management practices.

While mgmt tried to address these issues days ago, highlighting them to be largely re-location-related (Jaipur), we think this has not been an issue for other regional-focused lenders; hence, we do not take the explanation at face value as well.

…but does highlight a larger issue
This does highlight a larger issue for AU with stretched valuations and relatively lower comfort on asset quality. For AU to become a successful large bank, we believe team building remains a critical aspect and instability around critical functions like risk does raise a question mark over the bank’s ability to scale up to a large BS size.

Why still not negative?
We think AU’s long-term story remains intact with strong growth trajectory and higher book compounding, in addition to a universal bank optionality. Further, AU’s asset business has always been built on strong moats including wheels, SBL (small business loans) and affordable housing, and now the liability profile is also scaling up well. We, hence, think premium valuations will sustain, and maintain Neutral.

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