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  • Stock Recommendation | RBL Bank - ADD - Target price : 500

    Publish date: OCTOBER 24, 2018

    Turning positive. RBL Bank delivered a solid performance on most operating metrics with earnings growth of ~36% yoy on the back of 40% yoy revenue growth. Loan growth was strong at 37% yoy and NIM saw a marginal improvement partly reflecting the shift in asset mix. RoE improvement is steady but the bank needs capital to sustain the current pace of growth. We upgrade the stock to ADD (TP unchanged) from REDUCE, post the recent underperformance, after being negative on the stock since our initiation.

    RBL Bank reported a solid performance on most operating metrics. Earnings grew 36% yoy on the back of 40% yoy revenue growth led by healthy NII growth of 41% yoy and 38% yoy growth in non-interest income. Gross and net NPL ratios were stable qoq at 1.4% and 0.7% with credit costs at ~1% of loans. Slippages were low at 1.3% of loans but agriculture remains the key area of concern. Cost-income ratio was stable qoq at ~51%.

    As we have been highlighting in our previous notes, the bank is building a balance sheet that is different from other private banks. Revenues are being built on two risky pillars—(1) MFI business and (2) credit cards. The revenues from these two businesses will aid investments and RoE improvement. The MFI business is back on track after having gone through a tough phase post demonetization while the credit card business is yet to reach peak profitability due to high acquisition costs. The bank has indicated that it would like to see its card base closer to 3 mn by FY2021 from 1.2 mn currently (0.6 mn in 2QFY18). RoEs/earnings risks are quite high and may have to be revised sharply given the duration of these loans, in case of cycle reversal.

    The growth in operating expenses (33% yoy) shows greater emphasis on non-staff expenses (52% yoy) as compared to staff costs (5% yoy) as there was negligible growth in headcount (3% yoy) and branch addition (22 yoy and two branches qoq). While the management has highlighted that investments on other businesses have not slowed but moved towards alternate channels, we believe asset-side expenses are taking a higher share than estimated earlier.

    We upgrade RBL Bank to ADD from REDUCE with an unchanged TP of ₹ 500 valuing the bank at 2.3X book and 16X September 2020E EPS for RoEs in the range of 13-15% in the short term. Recent underperformance gives us an opportunity to turn positive after being negative since our initiation. RoE improvement is likely to be gradual as the pace of growth in balance sheet implies capital infusion is needed to maintain its current pace of loan growth.

    Stable trends on asset quality; NPLs in the agriculture portfolio peak

    ▶ RBL Bank reported stable gross NPL and net NPL of 1.4% and 0.7%, respectively in 2QFY19. The net stressed assets are quite negligible. Slippages marginally declined by 20 bps qoq to 1.3% in 2QFY19. MFI portfolio saw improvement in GNPL as it declined to 1.5% of loans from 2% of loans in 1QFY19. Provision coverage (calculated) increased to 47% (up ~70 bps qoq).

    ▶ RBL’s GNPL saw stable performance in the corporate segment at 0.5%. GNPL in the commercial banking space marginally increased to 3% (up ~30 bps qoq). Additionally, there was marginal deterioration in asset quality for the retail portfolio by ~15 bps qoq (GNPL at 1.6% of loans). GNPL in the agriculture portfolio has observed a very sharp increase of 200%. Write-offs have been primarily in the credit cards and MFI portfolio.

    ▶ As the company rapidly expands its card base, retail asset quality needs to be monitored going ahead. The bank has a negligible exposure of `150 mn to IL&FS through a guarantee and a minor derivative position which the bank currently needs to pay to the client. The exposure to NBFC and real estate is towards better-rated companies where the management indicated that the risk of default is quite low.

    ▶ In line with our conservative stance, we expect gross NPL of around 1.6-2% and credit costs of 100 bps over the medium term (FY2018-20E).

    Robust loan growth at ~37% yoy; retail dominates growth at 45% yoy

    RBL’s 37% yoy and ~9% qoq loan growth was driven by 33% yoy growth in the wholesale book while the non-wholesale book has grown by 23% yoy. Last quarter saw a change in the loan portfolio definition with the agriculture portfolio now getting distributed between commercial banking and retail assets.

    Within the non-wholesale book, retail assets were solid at 45% yoy followed by DB&FI which witnessed 37% yoy growth. Within the retail book, credit cards and personal loans witnessed highest growth. A total of 0.26 mn new credit cards (total outstanding of 1.2 mn cards) were issued in 2QFY19. Within DB&FI, micro-banking and MSME business (on a low base) saw rapid growth at 55-60% yoy. The company is swiftly increasing its BC network to grow this book at a fast pace. Additionally, geographic diversification remains paramount for this business (the company is present in 19 states with no state contributing more than 15% of the business).

    Wholesale segment loan growth was robust at 33% yoy. Within the wholesale book, corporate and institutional banking grew at 36% yoy whereas commercial banking increased by 27% yoy. RBL is targeting to reach a 50:50 split between wholesale and nonwholesale segments, compared to 60:40 split now. Our forecasts build 25-30% loan CAGR over FY2017-20E.

    The importance of the two lines of business: ~35% of revenues

    We are making marginal modifications to the table that we have reported last quarter. Exhibit 16 shows the contribution of the credit card and MFI business. This is a pure hypothetical exercise based on external and internal inputs. The management has not given us any specific number on any line item and we have used the performance of other MFI for the bank’s MFI business and the performance of SBI Cards and Payment Services for the credit card business of RBL. Based on this exercise we probably see the importance of these two businesses, which contribute ~15% of the overall loan book. We believe that the card and MFI business contributes 16-17% of revenues each.

    The management highlighted that the portfolio is generating returns better than the bank’s reported numbers. The throughputs of the cards business have been quite impressive when we look at the number of transactions, spends and average transaction/card (see Exhibit below). The conversion to term loans is quite stable at ~20% and these loans are for less than 6 months. Fees are quite healthy with ~40% from interchange and the balance split between annual, processing and others fees (late payment, penal, forex, write-back, etc.).

    We estimate that these two businesses could be contributing 30% of the overall expenses of the bank. The management indicated that it would want a substantial increase in its credit card base in FY2019 (1.8 mn from 1.2 mn currently) and 3 mn by FY2020 and 5 mn by FY2021. This would entail quite a lot of expenses upfront as most of it would be origination costs. We don’t have the contractual details that the bank has with Bajaj Finance.

    On the other hand, the MFI business is seeing two good tailwinds. Growth has picked up and NPL risk is receding. This implies one could see significant contribution to profits from this business in the next few quarters.

    CASA ratio stable at 25%; growth in CA has been stronger

    RBL reported ~30% yoy growth in deposits, driven by 35% yoy growth in CASA balance. Traction is SA was modest at ~11% yoy (up 4% qoq) growth while CA growth was relatively stronger at 77% yoy (up 9% qoq). CASA ratio was stable qoq at 25% of deposits. Currently CA and SA have similar shares in CASA at ~50% each. The average cost of savings account balances was broadly unchanged at 6.3% with the deposits greater than ₹10 mn maintained at ~40%.

    We estimate ~27% CASA ratio by FY2020E driven by ~40% CAGR increase in SA balances during FY2017-20E.

    Other highlights for the quarter

    ▶ NIM improves yoy. NIM improved ~10 bps qoq to 4.1%. Yield on advances increased 20 bps qoq to 10.9% in 2QFY19 though this was offset by a marginal increase in cost of funds to 6.4% in 2QFY19. The yield on wholesale book remained stable during the quarter. In light of the change in the loan mix we are building a NIM to remain at elevated levels though there is likely to be some pressure on the back of rise in wholesale cost of deposits. A faster build out of retail loans coupled with improved CASA ratio will provide upside to our margin assumptions.

    ▶ Cost pressure was stable but investments in business to remain high. Cost-income ratio was high at 52% in 2QFY19 but it was an improvement of 300 bps yoy. Operating expenses increased 33% yoy whereas employee expenses were up 5% yoy while nonstaff expenses grew 54% yoy. Overall employee base grew by 3% yoy for a loan book that is growing at ~35% CAGR. The management highlighted that it has shifted some of its employees from the bank to its subsidiary as it was cost efficient. Non-staff costs growth has been much faster indicating the shift in the mix of loan book towards businesses where there is greater outsourcing through its own subsidiary (Swaadhar) and to external clients (Bajaj Finance and DSA) for the credit card business.

    ▶ Capital position remains comfortable. Capital position remains stable with CAR of 13.7% (down 90 bps qoq) and tier-1 of 12.5% (down 60 bps qoq). RWA growth was at 33% yoy.

    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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