AXIS BANK PRICE: RS.854

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1 MANAGEMENT MEET UPDATE Saday Sinha AXIS BANK PRICE: RS.854 RECOMMENDATION: BUY TARGET PRICE: RS.1230 FY13E P/E: 7.5x, P/ABV: 1.4X Trend in Advances (Rs bn) Key takeaways: Modeling lower loan growth but NIM for FY12 is likely to come near upper band of the management guidance. Concerns on asset quality might impact the stock performance in near-term, but it is currently available at a significant discount to its historical average. Hence, we advise our clients to look at this opportunity with medium to long term horizon. Modeling lower loan growth (19-20% during FY12/13 on slowing economy and increase in the risk of asset quality deterioration as against the management guidance of 22-23%); NIM for FY12 is likely to come near upper band of the management guidance ( %). We are modeling NIM at 3.39% and 3.28% during FY12 & FY13, respectively, as compared to 3.65% witnessed during FY11. Although asset quality remained healthy till Q2FY12, perceived risk has amplified with high exposure to infrastructure and other stressed sectors; key things to watch would be restructuring of infra book or MFI exposure. Axis bank has inflated contingent liability (187% of assets) at the end of FY11, another area of concern, in our view. For FY11, after applying CCF at 75% (average of 50% CCF applied on "Transaction and Performance Guarantee" and 100% CCF applied on "Direct Credit Substitute Guarantees"), CEA comes at Rs bn (16.7% of assets at the end of FY11), a higher number by any standard. Lower net profit growth during FY12/13E along with higher risk on asset quality might warrant some kind of de-rating; hence, we are cutting the P/ABV multiple from 2.5x to 2.0x. We maintain BUY rating on the stock with revised TP of Rs.1230 (Rs.1500 earlier) based on P/ABV of 2.0x its FY13E adjusted book value. We recently met with the management to understand the business outlook and their strategic intent during current uncertain macro-economic environment. We believe concerns of high exposure to infrastructure and other stressed sectors might come in the way of stock performance in near-term, stock is currently available at a significant discount to its historical average. Hence, we advise our clients to look at this opportunity with medium to long term horizon. Modeling lower loan growth but NIM for FY12 is likely to come near upper band of the management guidance. We are further cutting the loan growth assumption to 19-20% during FY12/13 on slowing economy and increase in the risk of asset quality deterioration as against the management guidance of 22-23%. We have seen the moderation in the loan growth during last two quarters when loan book grew 21.4% (Q1FY12) and 26.7% (Q2FY12), respectively. 1Q2011 2Q2011 3Q2011 4Q2011 1Q2012 2Q2012 YoY Gr (%) Large & Mid Corporate SME Advances Agriculture Retail Total Advances (Rs. Bn) 1, , , , , , Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

2 Breakup of Advances (Q2FY12) We also expect NIM for FY12 to come near the upper-band of management guidance ( %). NIM during Q2FY12 improved to 3.78% (10bps YoY; 50bps QoQ) on back of CASA improvement, stable funding costs (cost of funds rose only 6bps QoQ) and ~50 bps (calculated) improvement in yield on assets. NIM for H1FY12 came at 3.53%; we have seen over the years that NIM during Q2/ Q3 to be slightly higher than Q1/Q4. We are modeling NIM at 3.39% and 3.28% during FY12 & FY13, respectively, as compared to 3.65% witnessed during FY11. Trends in NIM (%) Strong liability franchise has aided in achieving healthy NIM; Fee income is likely to grow at the slower pace, in our view Axis bank has strong liability franchise visible from one of the best CASA mix in the industry. CASA share saw improvement from 40.5% at the end of Q1FY12 to 42.2% at the end of Q2FY12. The bank has been focusing on increasing the retail deposit base; CASA deposits grew at a CAGR of 38.4% during FY04-11 while total deposits grew at 36.9% CAGR, during the same period. Out of this CASA deposits, SA (saving deposits) grew even at the faster rate (48.3% CAGR) during FY Management has guided that Fee-based income which was growing at the faster pace than the B/S growth will now grow in line with the latter. We are modeling fee-based income to grow at a CAGR of 18.0% during FY11-13 as against 51.9% CAGR achieved during FY Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3

3 Although asset quality remained healthy till Q2FY12, perceived risk has amplified with high exposure to infrastructure and other stressed sectors; key things to watch would be restructuring of infra book or MFI exposure. Although asset quality remained healthy till Q2FY12 with gross NPA and net NPA at 1.08% and 0.34%, respectively, perceived risk has amplified with high exposure to infrastructure and other stressed sectors. Trends in asset quality NPA (Rs bn) Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Gross NPA % of Gross Advances Net NPA % of Net Advances Provision Coverage Ratio (%) Sectoral Exposure (%) (Q2FY12) Total Fund-based Non-fund based Power Generation & Distribution Other Infrastructure (roads, ports, airports etc) Metal & Metal Products Food Processing Financial Companies Real Estate ; Financial companies stands for HFC & other NBFCs Axis bank has ~Rs.6.5 bn worth of MFI exposure at the end of Q2FY12. During Q2FY12, Rs.3.1 bn was restructured, out of which Rs.2.3 bn came from MFI segment. We are expecting similar kind of restructuring on MFI exposure and even some slippage from earlier restructured book. Its cumulative restructured book stands at Rs.21.5 bn (~1.7% of net advances). Inflated contingent liability: another concern for the stock Axis bank has inflated contingent liability (187% of assets) at the end of FY11, another area of concern, in our view. We have also tried to apply CCF (credit conversion factor) as per RBI's guidelines to arrive at CEA (credit equivalent amount). For FY11, after applying CCF at 75% (average of 50% CCF applied on "Transaction and Performance Guarantee" and 100% CCF applied on "Direct Credit Substitute Guarantees"), CEA comes at Rs bn (16.7% of assets at the end of FY11), a higher number by any standard. Contingent Liabilities (Rs bn) FY06 FY07 FY08 FY09 FY10 FY11 Claims not acknowledged as debt Outstanding forward exchange & derivative contracts , , , , ,728.8 Liability for partly paid investments Guarantees given on behalf of Constituents Acceptances, Endorsements etc Disputed Claims Others Total Contingent Liability , , , , ,540.0 As % of Total Assets Growth (%) Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4

4 However, derivative exposure which looks bloated (154% at the end of FY11) does not impact the CEA (credit equivalent amount) much (~3.0% of assets) when we apply CCF (credit conversion factor). Valuations & recommendation At the current market price of Rs.854, the stock is trading at 7.5x its FY13E earnings and 1.4x its FY13E ABV. Although there are concerns like high exposure to infrastructure and other stressed sectors which might come in the way of stock performance in near-term, stock is currently available at a significant discount to its historical average. Hence, we advise our clients to look at this opportunity with medium to long term horizon. We are modeling healthy earnings which is likely to grow at 17.5% CAGR during FY11-13E and strong return ratios (RoE: ~20%, RoA: ~1.5%) during FY12/13E after taking into account higher slippage, going forward. Lower net profit growth during FY12/13E along with higher risk on asset quality might warrant some kind of de-rating; hence, we are cutting the P/ABV multiple from 2.5x to 2.0x. We maintain BUY rating on the stock with revised TP of Rs.1230 (Rs.1500 earlier) based on P/ABV of 2.0x its FY13E 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) E 2013E Interest income Interest expense Net interest income Growth (%) Other income Gross profit Net profit Growth (%) 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