Prabhudas Lilladher has issued an “Accumulate” rating for AAVAS Financiers, with a target price of Rs1,900, implying a moderate potential upside from the current price of Rs1,715. Despite a challenging quarter marked by weak disbursement and narrower Net Interest Margin (NIM), AAVAS maintains a positive outlook. The research projects a YoY Asset Under Management (AuM) growth of ~20% for FY25, driven by a revival in disbursement rates. Operational cost management and improved provisions have cushioned profits, despite slower-than-expected yield re-pricing.

Quarter Performance Highlights: Weak Disbursals but Resilient Profit

Softer Disbursements and Narrower NIMs
AAVAS posted a soft Q2FY25, with net interest income (NII) falling to Rs2.42 billion against a projection of Rs2.52 billion. This dip was attributed to subdued asset growth and a lower NIM, recorded at 5.84%—a miss compared to the anticipated 6.05%. Despite a reduction in income, Profit After Tax (PAT) was largely in line due to lower operating expenses, aided by a one-time ESOP cost reversal, and lower provisions.

Factors Influencing AAVAS’s Financial Performance

One-Time Events Impacting Disbursal Rates
Disbursements were hampered by an extended monsoon and a temporary Loan Management System (LMS) shutdown, which disrupted cash flow. These interruptions are, however, considered temporary setbacks, with management reporting a notable 22% increase in disbursement levels for September and October, signaling recovery potential.

Revised Growth and Margin Forecast

Adjustment in AuM Growth and NIM Targets
Based on the H1FY25 performance, Prabhudas Lilladher has reduced its projected AuM growth for FY25 to 17% from the previous 20%, reflecting an expected moderation in loan disbursement. Additionally, the FY25/26 NIM has been trimmed by 35/17 basis points due to slower yield re-pricing and a 15bps impact from balance transfer (BT-out). The disbursal yield for the first half was also 30bps below the portfolio yield.

Cost Efficiency Through Digital Transformation

Operational Efficiency to Improve by 20-30bps in FY25
Ongoing digital transformation is aiding AAVAS’s operational efficiency, particularly in sourcing, disbursement, and collection processes. This cost management is expected to reduce operating expenses by ~9% for FY25/26, leading to an anticipated 20-30bps improvement in the operating expense-to-asset ratio.

Financial and Valuation Outlook

Valuation Upgraded to Rs1,900 with a Slightly Lower Multiple
Prabhudas Lilladher values AAVAS Financiers at 2.9x Price-to-Adjusted Book Value (P/ABV) for FY26, a slight adjustment from the prior 3.0x. This valuation is supported by an anticipated forward book value of Rs703.7 for FY27, translating to a target price of Rs1,900.

Asset Quality and Risk Management

Moderate Asset Quality Decline and Stable Provisions
Asset quality remained relatively stable, with Gross Non-Performing Assets (NPA) at 1.08%, a 7bps increase QoQ, attributed to slight portfolio slippages. Provision coverage remained steady at 27.8%, suggesting AAVAS’s cautious stance on managing credit quality, while credit costs are guided to remain under 25bps for the fiscal year.

Investment Rationale and Key Investor Takeaways

Target Price: Rs1,900 (Current Market Price: Rs1,715)
Recommendation: Accumulate

Upside Potential: Prabhudas Lilladher’s target implies a potential upside of approximately 10.8% from current levels, aligning with an “Accumulate” stance.
Growth Forecast: AuM is expected to grow 17-18% annually over FY25-27.
Yield Stabilization: Although NIM is forecasted to contract slightly, incremental yield is expected to rise by 25bps, partially offsetting the decline.
Efficiency Gains: Digitalization efforts and cost control measures are likely to improve operational efficiency, enhancing profitability margins.
Risk Factors: Any deviation in disbursement growth, adverse interest rate changes, or asset quality deterioration could impact AAVAS’s performance.