1. RESULT UPDATE 26 th October, 2017
Oct/14 Apr/15 Oct/15 Apr/16 Oct/16 Apr/17 Oct/17 India Equity Institutional Research II Result Update Q2FY18 II 26 th October, 2017 CMP INR 1014 Target INR 1104 Result highlights Potential Upside 9% Market Cap (INR Mn) 1,922,473 Stable quarter; asset quality improves Recommendation ACCUMULATE Sector BFSI 2 Q2FY18 performance was a strong with advances growing 21.1% yoy (7.2% qoq) to Rs. 15,25,741 mn, while interest income grew 7.9% yoy (2.2% qoq). With NIMs remaining within the bank s guided range of 4.25%, NII grew at a good pace of 16% yoy and 3% qoq (CoF down 90 bps yoy and yields down 130 bps). Calculated annualized NIM was 4.1% against 4.3% for Q2FY17 and 4.2% for Q1FY18. CASA saw healthy growth of 44% yoy and 10% qoq, (CASA ratio 47.8% versus 43.9% for Q1FY18, 39% for Q2FY17). Cost/income ratio stands at 47.2% versus 49.1% for Q2FY17 and 49.4% for Q1FY18. PAT was slightly below our expectations, at Rs. 9,943 mn, up 22% yoy and 9% qoq. On the asset quality front, the Bank has shown improvement as its gross NPAs stand at 2.47%, down 2 bps yoy and 11 bps qoq. Net NPAs, at 1.26%, are up 6 bps yoy and 1 bp qoq. Despite the strong traction in corporate loan book and given the current corporate lending environment, the Bank has been able to maintain its asset quality over the last many quarters. MARKET DATA Shares outs (Mn) 1904 EquityCap (INR Mn) 9520 Mkt Cap (INR Mn) 1922473 52 Wk H/L (INR) 1114/692 Volume Avg (3m K) 1948.6 Face Value (INR) 5 Bloomberg Code KMB IN SHARE PRICE PERFORMANCE 200 160 120 80 Sensex Kotak Mahindra MARKET INFO SENSEX 33043 NIFTY 10295 KEY FINANCIALS Particulars (INR Mn) FY15 FY16 FY17 FY18E FY19E FY20E Net Interest Income 42,237 69,004 81,261 88,504 1,00,535 1,20,642 Pre-provision profits 29,975 40,411 59,848 73,145 91,929 1,20,430 Net Profit 18,660 20,898 34,115 39,365 49,979 65,824 EPS ( ) 24.2 11.4 18.6 21.4 27.1 35.8 BVPS ( ) 183.1 130.6 150.0 170.3 196.1 230.1 P/BV (x) 3.7 5.2 5.8 6.0 5.2 4.4 Source: Company, Strong advances growth across segments Corporate banking grew 26% yoy and forms 32% of the total loan book, remaining largely unchanged qoq but up ~140 bps yoy. Share of CV/CE has inched up by ~70 bps yoy (growth at 33% yoy) but remains flat on qoq basis. Small business/pl/cc saw robust growth of 32% while LAP grew at 20%. Agriculture loans seem to have continued their growth momentum after staying muted in Q2/Q3FY17 (growth at 14% yoy; 6% qoq). Business banking growth was slightly depressed growing at 4% yoy and 3% qoq. On account of bank s aim to double its customer base over the next 18 months, we expect strong retail traction going forward. The bank through its 811 strategy expects the consumer segment to grow at a robust pace. Customer assets grew 20.7% yoy and 6% qoq. Going forward, we expect loan book to grow at 20%. On the wholesale side, the bank maintains its stance on dealing only with good quality customers with better ratings. The bank, through Kotak Mahindra Prime, also plans to launch consumer durable financing, thus upping its consumer game. As the gestation period is long in consumer durable financing, the bank wants to scale up this business in a steady manner without compromising on credit quality. We believe growth in consumer durable financing to add to the bank s profitability owing to higher NIMs. Improvement in cost/income despite extra costs related to PSLC and 811 marketing Operating expense, which grew 11.2% yoy, included PSLC and 811 marketing expenses which were not there last year. Despite these extra costs, cost income ratio stands at 47.2% which is already lower on yoy basis. Going forward, the operating expense should normalize and cost income ratio should improve as the bank carries out digitization of processes. SHARE HOLDING PATTERN (%) Particulars Sep 17 Jun 17 Mar 17 Promoters 30.07 30.08 31.04 FIIs 39.86 40.19 39.7 DIIs 8.47 8.23 8.39 Others 21.6 21.5 20.87 Total 100 100 100 20% 14% Advances CAGR between FY 17 and FY 20E NII CAGR between FY 17 and FY 20E
Continued CASA growth and stable NIMs 3 CASA deposits grew 44% yoy and 10% qoq with CASA ratio standing at 47.8% for the quarter. Savings deposits, which cost 5.51%, grew at a robust pace of 62% yoy while CA deposits grew at 17% yoy. Adjusting for the government business, growth in SA stands at more than 40%. Going forward, the bank envisages high growth in CASA along with improvement in total deposits mix. CASA and TDs below Rs. 5 crore make up more than 75% of the total deposits for the bank. On account of offering a relatively higher savings rate (200 bps over the average) and the bank s strategy to build a stable liability base, we expect KMB will be able to grow its low cost deposits at a significant pace and will be able to garner a larger share of the total deposits in the system as the bank sees huge opportunities for market share gains. Part of belief is based on the bank s 811 strategy which helps the bank acquire customers at a significantly lower cost. NIMs at 4.1% have contracted slightly, by 25 bps yoy and 10 bps qoq partially on account of interest reversal. We are also of the view that strong competition within the good quality corporate credit has played its part in NIM contraction. However, the bank has guided for sustainable NIMs of 4.25% on back of which it could a build a decent book. We believe the bank to deliver on its guidance on back of high quality underwriting, focus on retail segment along with penetration in younger segments (through 811) and risk-adjusted returns. Improved asset quality with undeterred focus on high quality credit underwriting The bank considers quality risk underwriting of utmost importance. This is reflected in KMB s gross NPAs which improved 11 bps qoq and 2 bps yoy with no indications of asset quality stress (SMA2 + standard restructured form only 0.20% of the net advances). The bank s lending philosophy and its focus on risk-adjusted pricing/returns and credit quality has led to such asset quality performance and we expect it to continue going forward. The bank s credit cost for the quarter was 0.42 bps and is expected to decline going forward. With respect to the 12 accounts identified by the RBI, the bank has exposure to only 4 of them, which it acquired inorganically through INGVysya. Further with respect to the accounts identified by the RBI in its second list, KMB has very small exposure which are provisioned for more than adequately. On standalone basis, the bank never had any exposure to any of the these NCLT/RBI-identified accounts. However, during the time of due diligence, it had identified 4 accounts (from the 1 st list) as potentially bad and had therefore provisioned for them adequately. Currently, the bank holds more than required provisioning against such (RBI-identified) accounts. This signifies the bank s grip on asset quality and its prudent provisioning policy when it recognizes potential stress. This reinforces our belief that KMB will continue to maintain tight asset quality going forward, irrespective of whether it grows organically or inorganically. Subsidiaries PAT performance: Kotak Mahindra Prime reported PAT at Rs. 1500 mn (up 15% yoy), Kotak Mahindra Investments reported Rs. 550 mn PAT (up 3.7% yoy), Kotak Sec reported Rs. 1180 mn PAT (up 23%), life insurance reported Rs. 1000 mn (up 58.7% yoy), Kotak Mahindra Capital Co. reported loss of Rs. 10 mn (against profit of Rs. 50 mn for Q2FY17) and KM AMC & Trustee reported Rs. 230 mn PAT (against Rs. 70 mn for Q2FY17). Overall, assets under management for the bank have increased to Rs. 16,92,140 mn, up 40% yoy. Valuation & Recommendation: We expect the bank to deliver 20% loan book CAGR over FY18-20E on back of faster customer acquisition through its 811 strategy and focus on consumer segment. We believe the bank s asset quality to improve tremendously on account of undeterred focus on quality loan underwriting without compromising on risk-adjusted returns (although we remain watchful on the NIMs as further contraction will be a negative). The fact that the bank has negligible exposure to the RBIidentified accounts makes the bank stand out. Further, we expect significant value creation through diversification of revenue streams by way of penetration into consumer durables finance, ~100% acquisition of BSS Microfinance and through asset management, securities and insurance businesses. Given the ROEs and scope for improvement, at current market price of Rs. 980 per share, we feel most of the value creation that is to come is priced in. Hence, we assign ACCUMULATE recommendation on the stock, valuing it at 4.8x FY20E BV translating into a value per share of Rs. 1,104, offering an upside of 9%. Key Ratios Q2FY18 Q2FY17 Q1FY18 Y-o-Y Q-o-Q Yield on avg advances % 9.3% 10.6% 9.8% -130-44 NIM % (calc) 4.1% 4.3% 4.2% -25-10 Cost to income ratio % 47.2% 49.1% 49.4% -185-220 CASA 47.8% 39.0% 43.9% 879 393 Gross NPAs 38,142 31,807 37,266 19.9% 2.3% Net NPAs 19,188 15,168 17,779 26.5% 7.9% GNPA % 2.47% 2.49% 2.58% -2-11 NNPA % 1.26% 1.20% 1.25% 6 1 CD ratio % 92% 89% 87% 275 503 Capital adequacy ratio % 18.36% 15.77% 19.21% 259-85 RoA % 1.68% 1.67% 1.61% 1 7 Leverage (x) 6.7 7.6 6.6 RoE % 11.3% 12.7% 10.6% -141 66 Source: Company,
4 Income Statement (INR Mn) Q2FY18 Q2FY17 Q1FY18 Y-o-Y Q-o-Q Interest income 47,601 44,125 46,558 7.9% 2.2% Interest expense 24,475 24,171 24,102 1.3% 1.5% Net interest income 23,127 19,954 22,456 15.9% 3.0% Noninterest income 9,539 8,311 9,069 14.8% 5.2% Total income 32,665 28,265 31,524 15.6% 3.6% - Employee costs 7,230 6,995 7,062 3.4% 2.4% - Other operating expenses 8,188 6,869 8,509 19.2% -3.8% Operating expenses 15,417 13,864 15,571 11.2% -1.0% Pre-provision profit 17,248 14,401 15,954 19.8% 8.1% Provisions 2,165 1,978 2,037 9.5% 6.3% Profit before tax 15,083 12,423 13,916 21.4% 8.4% Tax expense 5,140 4,290 4,789 19.8% 7.3% Net profit 9,943 8,133 9,127 22.3% 8.9% Source: Company, Balance Sheet items Q2FY18 Q2FY17 Q1FY18 Y-o-Y Q-o-Q Deposits 16,56,709 14,10,451 16,35,180 17.5% 1.3% Borrowings 2,59,229 1,98,132 1,96,960 30.8% 31.6% Investments 5,27,965 4,86,311 5,22,510 8.6% 1.0% Advances 15,25,741 12,60,152 14,23,590 21.1% 7.2% Total assets 23,69,695 19,50,600 22,63,850 21.5% 4.7% Source: Company, Key highlights from Q2FY18 earnings call: Macros: The bank feels there is gradual bottoming-out of interest rates taking place. Indian macros are likely to become favorable and the country will participate in the global growth. The bank has also seen proactive approach from the government in last few months to kick start the economy. The bank has reported zero divergence (against RBI s assessment) in asset quality. Further, SMA2 accounts stand at Rs. 250 crore while standard restructured loans amount to Rs. 65 crore. Credit costs remain in line with the guidance and continue to trend downards. NIM guidance has been maintained at 4.25%. The bank feels this level to be a sustainable one and believes it could build strong advances book on back such NIMs. Although during Q2FY18, there was some interest reversal on agri-loans which impacted NIMs to a certain extent. The bank s guiding pricing philosophy is that it always looks at risk-adjusted returns. The bank has been witnessing sustainable and stable business output along with improved credit quality. Advances growth has been across all the segments. Corporate grew at 26%, CV/CE at 33% and small business/pl/cc at 32%. Focus on digital is significant. 20% of the incremental cards business is coming through the virtual channel. Mobile banking growth has been 96% in value terms and 125% in volume terms. Apart from the standalone bank, subsidiaries also continue to focus on digital. On recapitalization bonds: The bank feels it is expected to kick-start the economic growth. PSBs are likely to become more bold and aggressive in taking hair-cuts and overall, the exercise will increase the chances of balance sheet cleansing. In light of the whole bad/stressed assets scenario, the bank continues to be guided by its own lending philosophy.
Key highlights from Q2FY18 earnings call (contd.): As a result of the recapitalization exercise, the bank expects settlements to start happening. Exposure to accounts mentioned in the 2 nd list of RBI is relatively small and is adequately provided for. Whatever exposure the bank has to the NCLT cases was never originated on the bank s own book but came from the ING-merger. As per the bank, its currently reported net-worth is lower than what would be reported under IFRS. Deposits base: The bank is focusing on rapidly acquiring customers on the liability side and building a deposit base. Savings account growth would be more than 40% without the government business, which reflects the bank s core ability to garner and grow its deposits. As per the bank, its savings deposits are growing much higher than the industry as it offers a rate 200 bps in excess of the market rate which helps in getting customers. Synergies from ING-Vysya: Branches have begun to see synergies however it feels there is little more room to extract. The bank is also witnessing synergies in terms of cross-selling of products among the customers. In the rural branches, the bank has seen significant improvement in customer acquisition. On the wholesale side, there has been some pressure on high quality credit yields due to competition from the bond market and commercial papers. That said, the bank will not lower its underwriting criteria and will continue to remain focused on quality and credit risk adjusted return/pricing. The bank continues to maintain a consistent focus on cost/income. The bank sees huge opportunity for market share gains. Hence, the bank is relentlessly focusing on acquiring liability as well as asset side business. 5
6 Kotak Mahindra Bank Date CMP (INR) TP (INR) Recommendation 26-Oct-17 1014 1104 ACCUMULATE 21-Jul-17 980 1104 ACCUMULATE 27-Jan-16 795 953 BUY 26-Oct-16 820 953 BUY 25-July-16 760 882 ACCUMULATE 12-May-16 739 882 ACCUMULATE 19-Jan-16 669 721 HOLD 03-Nov-15 685 720 HOLD 13-Apr-15 1,422 1,400 REDUCE 21-Jan-15 1,389 1,400 HOLD 7-Jan-15 1,251 1,260 HOLD 28-Oct-14 1088 1111 HOLD 8-Oct-14 1006 1050 HOLD 16-Jul-14 884 1000 ACCUMULATE Rating Legend Our Rating Upside Buy More than 15% Accumulate 5% - 15% Hold 0 5% Reduce -5% 0 Sell Less than -5% CERTIFICATION: We, Raghav Garg (B.Com, M.Com (Applied Finance)), research analyst and Amit Singh (B.E (Com), MMS-Finance), research associate, author and the name subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect my views about the subject issuer(s) or securities. 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