(Rs bn) < 1 Yr Share 1 Yr - 3Yr Share 3Yr - 5Yr Share > 5 Yr Share Total

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1 ANNUAL REPORT UPDATE Saday Sinha AXIS BANK PRICE: RS.1883 RECOMMENDATION: BUY TARGET PRICE: RS.2080 FY16E P/E: 11.5X, P/ABV: 1.9X Axis bank has favorable ALM with higher share of deposits in the < 1 Yr and 1 Yr - 3 Yr maturity buckets vis-à-vis advances in the same maturity buckets which is likely to support margins in the falling interest rate environment. Diversified fee-based income and superior liability franchise (CASA mix) are key strengths of the bank. It has consistently delivered superior NIM during previous several quarters largely on back of lower cost of funds which has been underpinned by strong CASA mobilization. Although headline NPLs (GNPA: 1.22% in FY14) have been holding well contrary to street expectations, high exposure to non-operational power portfolio remains a potential risk, in our view. Nonetheless, incremental stress build-up (slippages + restructuring) during FY14 came at Rs.56.9 bn, well within the management's guidance range (Rs.60 bn). At CMP, stock trades at reasonable valuation (1.9x FY16E ABV). We expect earnings to grow 11.1% CAGR during FY14-16E along with healthy return ratios (RoE: ~17%, RoA: 1.6%). We are raising TP to Rs.2080 (Rs.1721 earlier; 2.1x FY16E ABV) on improving macros and retain BUY rating on the stock. Favorable ALM likely to support margins in the falling interest rate environment Axis bank has favorable ALM with higher share of deposits in the < 1 Yr and 1 Yr - 3 Yr maturity buckets vis-à-vis advances in the same maturity buckets. We believe this would support margins in the falling interest rate environment as larger amount of deposits as compared to advances would come for re-pricing at lower interest rates. So, even though benefits from recapitalization done during Q4FY14 tapers, cost of funds is not likely to rise as ~47% of deposits would be re-priced at lower interest rate while only ~17% of advances is likely to be re-priced at lower yields. Trend in deposit maturity profile (Rs bn) < 1 Yr Share 1 Yr - 3Yr Share 3Yr - 5Yr Share > 5 Yr Share Total FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % Trend in advances maturity profile (Rs bn) < 1 Yr Share 1 Yr - 3Yr Share 3Yr - 5Yr Share > 5 Yr Share Total FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % FY % % % % Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

2 Liability franchise one of the best in the industry; retail banking segment has been key drivers of its growth strategy Axis bank has built a robust liability franchise, displayed in its CASA mobilization. Its CASA mix (40-46% during FY06-14) has been one of the highest in the industry on back of its three-pronged strategy: Strategy of expanding its network to hinterland, where competition is relatively lower. Better customer segmentation strategy, which helps in developing customized products. Focus on transactional banking products which help in getting higher floats from the customers along with generating consistent fee-based income. Trend in CASA mix (%), Kotak Securities - Private Client Research Improvement in the liability franchise has helped Axis bank over the years to reduce its funding costs. During FY14, even though the banking system was witnessing migration of CASA deposits, Axis bank's average CASA share saw improvement to 38.9% (FY14) as compared to 36.3% in the previous year. Apart from low cost CASA deposits, improvement in the retail TDs (54.5% in FY14 as compared to 43.7% in FY13) and raising of equity capital during Q4FY13 have enabled the bank to contain its cost of funds. Trends in NIM (%) Cost of deposits saw 30bps improvement to 6.43% in FY14 largely driven by decline in cost of TDs (27bps; 8.83% in FY14). As a result, cost of borrowings declined from 6.55% in FY13 to 6.24% in FY14. Apart from remarkable performance on funding side, 16bps improvement in yield on earning assets, aided in 28bps improvement in NIM during FY14 (3.81%). We believe prevailing LDR provides limited scope and hence mobilizing deposits would be the key to fund its loan growth. Hence, we are modeling NIM to come at 3.7%/3.6% during FY15/16E, as pricing power is likely to shift to borrowers with asset mix shifting towards retail segment. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3

3 Fee Income has been healthy contributor to total revenue stream; focus on operating efficiency continues For Axis bank, contribution of fee-based income to total income has been consistently in the range of 35-37%, healthy in our view. Its fee income remains well diversified with 32% coming from retail banking, 30% from corporate banking and balance contributed by treasury, BB, SME and agri segments. Composition of net revenue (NII + Other Income) FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 NII 51% 62% 58% 59% 59% 56% 56% 59% 60% 60% 62% Fee Income 19% 35% 33% 36% 35% 38% 34% 35% 37% 35% 36% Trading Profit 29% -1% 8% 2% 5% 4% 8% 3% 1% 4% 2% Other non interest Income 1% 4% 1% 2% 1% 1% 2% 3% 2% 2% 1% Total Income 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Despite rapid expansion in its branch network, it has managed its operating efficiency well. Its cost / Income ratio improved from 52.9% in FY05 to 40.8% in FY14. Bank has continued to focus on business re-engineering to reduce transaction costs besides ensuring smoothness in operations and enhancing its productivity. The moderate rise in opex was largely due to growth in bank's network and other infrastructures while salary paid to employees fell 2.8% YoY in FY14. We are modeling C/I ratio to come at ~42% levels in next two years (FY15/16E). Cost / Income ratio (%), Kotak Securities - Private Client Research Although headline NPLs suggest comfort, high exposure to nonoperational power portfolio remains a potential risk, in our view. Asset quality has been holding well contrary to street expectations - gross and net NPAs stand at 1.22% and 0.40%, respectively, at the end of FY14. Although slippage came marginally ahead during FY14 (1.29% annualized) as compared to 1.19% in FY13, incremental stress build-up (slippages + restructuring) came at Rs.56.9 bn in FY14, well within the management's guidance range (Rs.60 bn for the FY14). Trend in Asset Quality (Rs Bn) Q1 FY13 Q2 FY13 Q3 FY13 Q4 FY13 Q1 FY14 Q2 FY14 Q3 FY14 Q4 FY14 Gross NPA % of Gross Advances Net NPA % of Net Advances Provision Coverage Ratio (%) 79.0% 80.0% 81.0% 79.0% 80.0% 80.0% 78.0% 78.0% Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4

4 Trend in addition to impaired assets (Rs Bn) Q Q Q Q Q Q Q Q Restructuring as a % of loan book 1.48% 0.76% 0.87% 1.86% 1.39% 2.09% 1.36% 2.26% Slippage Slippage Ratio (%) 1.07% 1.48% 1.27% 0.90% 1.38% 1.26% 1.20% 0.61% Addition to impaired assets (%) 2.55% 2.24% 2.14% 2.76% 2.78% 3.35% 2.56% 2.88% Its outstanding restructured book is relatively comfortable at Rs.60.8 bn (2.64% of net advances) as per the new classification (up-gradation of loans that have completed >2 years of satisfactory performance). However, we believe risk of asset impairment remains high due to its high exposure to infrastructure and other stressed sectors. Moreover, out of total power portfolio, only ~1/3 assets are operational in nature. We believe, healthy provision coverage ratio at ~78% (including prudential write-offs) at the end of Q4FY14 provides some comfort, in our view. We recommend BUY on Axis Bank with a price target of Rs.2080 Valuations & recommendation At CMP, stock trades reasonable at 11.5x its FY16E earnings and 1.9x its FY16E ABV. We expect earnings to grow 11.1% CAGR during FY14-16E along with healthy return ratios (RoE: ~17%, RoA: 1.6%). We are raising TP to Rs.2080 (Rs.1721 earlier) on improving macros and retain BUY rating on the stock based on P/ABV of 2.1x its FY16E adjusted book value. Rolling 1-year forward P/ABV band, Kotak Securities - Private Client Research Rolling 1-year forward P/E band, Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 5

5 Key data (Rs bn) FY13 FY14 FY15E FY16E IInterest income Interest expense Net interest income Growth (%) 20.6% 23.6% 11.8% 12.6% Other income Gross profit Net profit Growth (%) 22.1% 20.0% 8.5% 13.6% Gross NPA (%) Net NPA (%) Net interest margin (%) CAR (%) RoE (%) RoA (%) Dividend per share (Rs.) EPS (Rs) Adjusted BVPS (Rs) P/E (x) P/ABV (x) , Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 6