Neutral: Recent exits reveal underlying issues in AU small finance banks

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Three people have left AU in the last three months, mostly from the audit and risk departments, causing the stock to plummet. The stock price drop of 10-15% (vs. NIFTY50 index up 2%) following the news of these exits, in our opinion, plainly reflects a far wider concern than the report suggests.

While we recognize that recent exits are mostly business-as-usual (BAU), and we prefer not to concentrate on them, the stock price reaction underlines concerns about stretched valuations and any potential asset quality risks, especially considering the areas where these exits have occurred.

We recently drew attention to various discrepancies in asset quality trends that we find difficult to fathom. While we remain bullish on AU’s long-term story, which includes a strong growth trajectory, universal bank options, and healthy book compounding, we are less optimistic about the near-term outlook, especially given valuations of 24x/3.8x Sep-23F EPS/book, which leave little room for disappointment; thus, we maintain our Neutral rating. Within the small financing banks (SFB) category, we prefer Equitas (Holdco; EQUITAS IN, Buy) to AU.

In the short term, don’t read too much into recent exits…

In the last three months, AU has lost three top-level executives: I Nitin Gupta (chief internal audit officer); (ii) Alok Gupta, who joined in Mar-21, resigned; and (iii) Sumit Dhir (Nitin Gupta’s replacement) resigned in less than five months. We point out that AU has a lot fewer top-level exits than rival SFBs, which have a lot more churn at the business head level as well. As a result, we do not believe this news is a significant negative on its own. Exits in audit/risk departments, on the other hand, raise questions about the book’s transparency and quality, as well as risk management processes.

While management attempted to address these concerns a few days ago, pointing out that they were mostly re-location-related (Jaipur), we do not believe this has been an issue for other regional-focused lenders; so, we do not accept the explanation at face value.

However, it does bring up a greater concern.

This does point to a wider concern for Australia, namely bloated valuations and a lack of confidence in asset quality. We believe that team development is still important for AU to become a successful large bank, and that volatility in essential departments like risk raises concerns about the bank’s capacity to expand up to a significant BS size.

Why isn’t it still negative?

With a robust growth trajectory and increased book compounding, as well as a universal bank choice, we believe AU’s long-term thesis remains intact. Furthermore, AU’s asset business has always been based on strong moats, such as wheels, SBL (small business loans), and affordable housing, and the liability profile is now scaling up nicely as well. As a result, we believe premium valuations will hold, and we remain Neutral.

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