Small finance bank stocks are on an uptrend. Does the rally have more legs?

Analysts believe that small finance banks have a much bigger role to play in the overall banking sector

Shares of small finance banks (SFBs) flexed muscles on the bourses in the month of April, after their March quarter business updates showed double digit growth in advances and deposits.

Suryoday Small Finance Bank stock price has jumped 20.4 per cent so far this month, while stock price of Ujjivan SFB has surged 18.3 per cent. ESAF Small Finance Bank stock price, Jana Small Finance Bank stock price, AU Small Finance Bank stock price, Utkarsh Small Finance Bank stock price, and Equitas Small Finance Bank stock price, meanwhile, have moved up in the range of 6.4 per cent to 10.2 per cent during the period.

By comparison, the Nifty50 index has slipped 0.8 per cent, while the Nifty 500 index has added 0.8 per cent, ACE Equity data shows.

As analysts see solid growth potential in small finance bank stock prices, they advise incumbent investors to stay put in their holdings. New investors, however, may wait for a better entry point, they added.

"India has strong catalysts for economic growth, thereby supporting credit demand outlook in the foreseeable future. We believe that small finance banks have a much bigger role to play in the overall banking sector," said Mohit Khanna, fund manager at Purnartha One Strategy.

At the current juncture, we remain invested in small finance bank stocks and would add to our positions in the pack if we get a better entry point due to market volatility, he added.

Growth spikes in Q4

According to analysts, small finance banks have been steadily gaining market share in the overall lending space by focusing on mobilising deposits at an accelerated pace. This was driven by offering term deposits at nearly 250bps higher than large banks.

Premium rates, coupled with accelerated investment towards liability-focused branches, led to steady build-up of the deposit base and gradual improvement in credit-deposit (CD) ratio.

Preliminary business updates showed that AU Small Finance Bank reported 25 per cent year-on-year (Y-o-Y) and 9 per cent quarter-on-quarter (Q-o-Q) growth in gross advances in Q4FY24, while its deposits grew 26 per cent Y-o-Y and 9 per cent Q-o-Q.

Similarly, Equitas Small Finance Bank’s advances grew 23 per cent Y-o-Y and 5 per cent Q-o-Q, while deposits jumped 43 per cent Y-o-Y and 12 per cent Q-o-Q.

Suryoday Small Finance Bank, meanwhile, reported a solid growth of 41 per cent Y-o-Y and 14 per cent Q-o-Q in advances, and 50 per cent Y-o-Y and 20 per cent Q-o-Q in deposits.

"Apart from comparatively better deposit rates than other private and PSU banks, the regulator's mandate to maintain a balanced CD ratio has prompted SFBs to aggressively ramp up deposits," said Dnyanada Vaidya, research analyst - BFSI at Axis Securities.

Going ahead, as credit demand momentum is expected to sustain, analysts expect deposit growth momentum to continue as well. The inability to do so could either restrict growth or weigh on margins, they added.

"We believe cost of funds (CoF) is near its peak, and margins could stabilise in the next couple of quarters. Investors can buy small finance bank stocks where the risk-reward is favourable," added Vaidya of Axis Securities. She prefers Equitas Small Finance Bank among the lot.

At present, the price to earnings (P/E) multiple of all but Suryoday Small Finance Bank stock and Utkarsh Small Finance Bank stock are in-line with their five-year average.

For the fiscal year gone by, CareEdge Ratings expects small finance bank advances and deposits to grow at 22-25 per cent and report stable profitability with return on total assets in the range of 2.1 per cent to 2.4 per cent.

Not a blanket benefit

That said, small finance banks' CD ratio remained elevated at 89 per cent, on average, at the end of the December quarter (Q3FY24), with certain financiers, including Suryoday Small Finance Bank, having elevated ratio of 111 per cent, Utkarsh Small Finance Bank 99 per cent, and Equitas Small Finance Bank 90 per cent.

ICICI Securities believes asset under management (AUM) growth could slow down for those small finance banks that have a CD ratio of 100 per cent.

"Overall, assuming 25 per cent loan CAGR between FY23-25E and CD ratio at 85 per cent by March, 2025, we expect the sector to clock 31 per cent deposit CAGR for between FY23-25," the brokerage added.