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  • Stock Recommendation | IndusInd Bank - BUY - Target price : Rs 1,850

    Publish date: OCTOBER 16, 2018

    A below-average quarter. IIB reported a muted performance with earnings growth of 5% yoy primarily due to 100% yoy growth in provisions (contingent provision to IL&FS). Loan growth was strong at ~32% yoy but higher cost of funds and slower non-interest income resulted in weaker revenue growth. Asset quality was stable qoq. The bank's disclosure to IL&FS could have been better as it does not address all concerns but recent price underperformance captures this, in our view. BUY call stays with TP revised to ₹1,850 (from ₹1,900 earlier).

    IIB reported 5% yoy earnings growth despite 22% yoy operating profit growth primarily on account of 100% yoy growth in provisions, largely for an exposure to the IL&FS group. Loan growth was strong at 32% yoy but NII grew 21% yoy primarily on account of higher cost of deposits and slower pass-through to loan book due to the mix and timing of this change. Retail loans grew 29% yoy and corporate loan book grew 35% yoy. Non-interest income grew 11% yoy primarily on account of lower treasury income. Asset quality was stable qoq with gross NPLs at 1.1% and net NPLs at 0.5%.
    The key discussion item for the quarter was the bank's exposure to the IL&FS group. Unfortunately, the bank has provided limited disclosures on the same: (1) ₹2.8 bn of provisions has been made to this exposure (classified as standard), which the management feels fully comfortable with, (2) exposure is primarily to the holding company (with a first right to cash flow) and exposure to a highly rated subsidiary and (3) IL&FS Securities Services transaction is likely to be completed shortly and the portfolio does not have any liability to the group debt. In the worst-case scenario, the management indicated that the provisions could be higher by 20- 25% than what has been provided so far if the exposure sees a higher-than-currentlyforecasted haircut. The disclosure to the group may not be relevant as the P&L can support the worst outcome but the context to this question is essentially on the high multiple that the bank enjoys led by its superior underwriting and its ability to limit any damage to the best possible extent.
    We upgraded IIB recently as the valuations are a lot more comfortable post the recent underperformance and do factor the possible downside earnings risks emerging from its exposure to the IL&FS group. The 2Q results may not have given full comfort but do provide a broad context to this exposure. Multiples have corrected and we retain our BUY rating with a TP of ₹1,850 (₹1,900 earlier) valuing the bank at 3.2X book and 20X FY2020E EPS for RoEs in the range of 16% and healthy earnings growth.

    Asset quality, barring exposure to the infrastructure company, stable qoq
    GNPL and NNPL ratios were flat qoq at 1.1% and 0.5%, respectively in 2QFY19. Slippages for the quarter dropped to 1.1% from 1.3% qoq. Provision coverage ratio continued to remain high at 56% (down 40 bps qoq). Corporate slippages declined by 70 bps qoq to 1.5% but the retail portfolio saw a marginal rise in slippages (30 bps qoq to 2.2%). The bank's exposure to IL&FS is still classified as standard. The exposure is primarily towards the group's holding company and a specific subsidiary, which has a relatively high investment rating. The bank's exposure to the holding company has first right of access to any cash flow accruing to the group.
    On the retail side, asset quality marginally deteriorated across most product classes indicated by rise in GNPL ratio. GNPL was 1% for CV (up 8 bps qoq), 4% for 2-Ws (up 23 bps qoq), 1.3% for UVs (down 5 bps qoq), 0.7% for CEs (down 15 bps qoq) and 0.8% for cars (up 10 bps qoq). Corporate slippages continue to show improvement and declined further to 0.5% from 1.2% in 1QFY19 and 2.5% in FY2018. The company has been gradually lending to companies with better credit profile.
    IndusInd Bank published movement in weighted average risk score of the vehicle finance book, which hinted at stable performance in portfolio quality. Within the vehicle finance book, MHCVs and cars demonstrate superior risk profile compared to others. We expect gross NPL ratio to be in the range of ~1.5% in medium term. We build in 1.6- 2.1% slippages and ~80 bps of loan-loss provisions over next few years.

    Margins shrink qoq as cost of funds starts to rise faster
    Reported margins compressed by ~10 bps qoq to 3.8% driven by rise in cost of deposits by 34 bps qoq during 2QFY19 while loan yields improved by 30 bps qoq during the same period. The rise in cost of deposits was on the back of rising cost of funds and slowdown in SA growth. Corporate yields improved substantially in 2QFY19 by ~50 bps qoq to 9.7%. Retail yields also improved by ~20 bps qoq.
    We expect NIM to improve primarily on the back of BHAFIN acquisition. We note that we are not factoring the full impact of BHAFIN merger at this point. The regulatory cost of BHAFIN on SLR/CRR is likely to be low considering that the balance sheet of BHAFIN has excess liquidity while the fully compliant PSL can help IndusInd Bank to lower its purchases of such loans from the market. Our key concern for a slightly more negative outlook comes from the standalone business where there is higher level of competition.

    Loan growth remains healthy; corporate loans gain traction
    Loan growth maintained strong momentum at 32% yoy in 2QFY19, a notch higher than those observed over the past few quarters. The retail segment witnessed ~30% yoy growth in 2QFY19, which was marginally lower than non-retail loan growth at 35% yoy. The company has demonstrated strong loan growth recording 27% CAGR over the past 5 years.
    Growth in retail loans was driven by both vehicle and non-vehicle portfolios with each recording similar yoy growth at ~29% yoy in 2QFY19. Vehicle loans have seen strong traction over the past four quarters witnessing 20%, 24%, 28% and 30% yoy growth, respectively. Within the vehicle finance portfolio, CV and UVs saw maximum growth at 34% and 28% yoy, respectively in 2QFY19, the pace of growth increasing gradually over the past four quarters. CEs also saw robust growth at 37% yoy. Growth in cars and 2-W was lower at 17% and 18% yoy, respectively in 2QFY19. Within the non-vehicle retail portfolio, credit cards continued to demonstrate strong growth at 48% yoy. Home loans/LAP also saw robust growth at 23% yoy. The share of home loans in the overall retail portfolio has broadly been stable at 28%.
    Within the non-retail portfolio, corporate loans witnessed 37% yoy growth in 2QFY19. SME book picked up pace after 2 quarters of modest growth and grew by 28% yoy in 2QFY19 (17% yoy growth in 1QFY19). The share of SME loans to corporate advances marginally improved to 30% in 2QFY19 (up 80 bps qoq) after declining for straight 4 quarters. The share of corporate lending to better-rated companies is on the rise.
    We factor loan growth at ~30% CAGR over FY2018-21E primarily led by BHAFIN acquisition. We expect retail loans to grow at ~25% CAGR. The vehicle finance portfolio would continue to dominate the loan book but the bank is aggressively diversifying into other products to reduce the cyclicality of this business. IIB maintains a cautious stance on the LAP portfolio due to high pricing pressure on this segment.

    CASA ratio stands high at 44%; SA growth momentum slows
    Deposit growth was slower-than-loan growth at 19% yoy resulting in a higher dependence on borrowings over the past few quarters. CA deposit growth was at 14% yoy (up 5% qoq). SA growth momentum slowed in 2QFY19 (27% yoy increase compared to 51% yoy increase in 1QFY19). CASA ratio marginally improved to ~44% in 2QFY19 (up 30 bps yoy). The bank has rapidly expanded its branch network (net addition of 56 branches qoq and 216 branches yoy), which is further expected to drive growth on the liability side. We do note that the bank is starting to give a higher weightage on mobilizing retail deposits, especially with the sharp rise in wholesale deposit rates.


    Other updates
    ▶ Fee income growth was strong at ~22% yoy led by strong general banking fees (up 40% yoy), foreign exchange fees (up 22% yoy) and trade fees and third-party fees growing by 18% yoy. Growth in investment banking fees was modest at 15% yoy whereas treasury gains dropped by 42% yoy owing to high mark-to-market losses.
    ▶ CAR stood comfortable at 14.3% with tier-1 ratio of 13.9%. RWA growth at 24% yoy was lower than 32% yoy loan growth in 2QFY19.


    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.


    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.


    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.


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