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Analyst Corner – Suryoday SFB: Initiate with ‘buy’ & TP of Rs 310

We initiate with a ‘buy’ rating and target price of Rs 310, valuing the stock at 1.8 FY23E book value.We initiate with a ‘buy’ rating and target price of Rs 310, valuing the stock at 1.8 FY23E book value.

Suryoday Small Finance Bank (Suryoday) is among the leading SFBs in India in terms of profitability — delivering >2% RoA in FY19-FY20, supported by cost efficiency (cost / assets at <5.5% in FY21) and higher NIMs.

Strong business growth with advances / deposits delivering 39% / 63% CAGR between FY18 and FY21, even during the transition phase, and ~80% retail deposits as at Mar’21 speaks of superior execution.

Though Suryoday’s retail asset journey has gone through its learning curve, better-quality growth is likely in the foreseeable future, driven by: 1) revamped business architecture with separate collection team, 2) stringent credit underwriting, and 4) focus on small-ticket secured loans in segments like SCV, affordable housing, etc. While Suryoday’s near-term asset quality concerns persist amid Covid resurgence, and its high exposure to MFI segment, we expect better and sustainable profitability in the longer term on the back of: 1) incremental focus on secured assets, 2) cost leadership, 3) adequate capital (CAR: 51%), and 4) conservative provision (bank is amongst the very few having a floating provision policy). We initiate with a ‘buy’ rating and target price of Rs 310, valuing the stock at 1.8 FY23E book value.

Cost leadership to ensure better profitability than peers: The most critical factor for most SFBs post getting licence in FY16-FY17, was to expand geographical reach to build a liability franchise, sustain high asset growth, and invest towards brand building, digital offerings, new business lines, etc. with minimal impact on profitability. However, very few, like Suryoday, succeeded in lowering total costs (by >150bps between FY18 and FY21), yet expand their distribution network by 32% and workforce by 21% during the same period. Optimal size of each bank branch, thus relatively lower opex per branch, end-to-end digitisation of many operations, including loan sourcing and higher proportion of variable compensation like ESOPs, are the key cost drivers. Suryoday contained its non-staff costs at <2% even during the expansion of its branch network from 241 in FY18 to 556 in FY21.

Fast-evolving granular deposit franchise: Post commencing SFB operations in CY17, Suryoday focused on building long-term sustainable sourcing, i.e. granular retail deposit base. Comprehensive product offerings, strategic presence in deposit-rich centres like metro and tier-1 cities, personalised customer service, and higher interest rates helped it increase the share of retail deposits to 80% by Mar’21 with CASA ratio at 15%.

Given its low base, it delivered 63% CAGR in deposits between FY18 and FY21 with much higher retail deposit growth. We believe, its fast-evolving granular deposit franchise will not only provide stable source of funding to grow AUM, but would also cushion margins from likely moderation in asset yields as it incrementally focuses on growing secured assets faster than MFI loans.

Credit cost normalisation and sustained cost leadership to drive profitability: While Suryoday delivered industry-leading profitability in FY19-FY20 (RoA >2%) supported by cost efficiency, its credit cost remained elevated at an average of >2% vs <1% for peers during the same timeframe.

Covid-led disruption is likely to keep credit cost higher in FY22E, but we expect profitability in FY23E and beyond to be driven by: increasing share of retail secured assets, resiliency of MFI borrowers, and cost leadership. We estimate RoA to reach 1.8% and RoE >8% by FY23E.

Key risks: A) higher MFI exposure in Maharashtra could result in lower collections than anticipated, and B) incremental growth coming at higher cost could result in higher cost / assets.

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