Higher operating expenses affect bottomline January 21, 2011 Abhijit Majumder abhijitmajumder@plindia.com +91 22 66322236 Umang Shah umangshah@plindia.com +91 22 66322242 Rating BUY Price Rs419 Target Price Rs531 Implied Upside 26.7% Sensex 19,047 (Prices as on January 20, 2011) Trading data Market Cap. (Rs bn) 304.9 Shares o/s (m) 727.6 3M Avg. Daily value (Rs m) 550.8 Major shareholders Promoters 45.61% Foreign 23.99% Domestic Inst. 5.84% Public & Other 24.56% Stock Performance (%) 1M 6M 12M Absolute (6.9) 7.1 (4.3) Relative (2.6) 0.6 (13.3) Price Performance (RIC: KTKM.BO, BB: KMB IN) Healthy core operating performance, higher opex affects bottom line: Kotak Mahindra Bank (KMB) reported consolidated PAT of Rs3.84bn, up 15.7% YoY and 5.3% QoQ and standalone PAT of Rs1.88bn, up 31.9% YoY, but down 3. 5% QoQ. While the consolidated PAT met our expectations, standalone PAT was lower than expected. For standalone banking operations, the operating expenses grew by 18.4% QoQ, with employee and other operating expenses growing nearly at the same pace. This was mainly on account of certain midyear salary hikes given for employee retention and higher advertising expenses towards the 25 years celebration campaign of the bank. Business growth stood healthy, with consolidated advances growing by 36.7% YoY and 6.9% QoQ, led by a sharp sequential increase in agri advances (up 12.8% QoQ), CV and construction equipment loans (up 11.5% QoQ) and mortgages (up 11.5% QoQ). Consolidated deposits grew strongly by 30.4% YoY, but declined by 0.8% QoQ. Importantly, CASA deposits declined by 12.7% QoQ, resulting into an over 400bps QoQ decline in CASA ratio to 27.8%. NIM declined by 20bps QoQ TO 5.4%. However, the margins have been normalized due to the impact of the strong recovery from a NPA account in Kotak Mahindra Prime, adjusting for the interest on recovery; the margins could have improved to ~5.6%. Large part of provisioning expenses pertains to the MTM provisions on G Secs. Asset quality improved as GNPAs declined by 0.9% QoQ. Provision coverage improved further to 68.4% from 66.3% in Q2FY11, and with technical write offs, it stood at 72%. Healthy performance by Kotak Prime and life insurance subsidiaries: Kotak Mahindra Prime reported a robust growth in bottom line, driven by a strong recovery from an NPA account, while overall disbursements continued to grow well. Capital market and asset management businesses continue to witness headwinds. On account of revised ULIP guidelines coming into effect, the overall premium growth got impacted, but tighter cost controls improved profitability. Key financials ( Y/e March) 2010 2011E 2012E 2013E Net interest income (Rs m) 28,283 29,495 36,323 43,769 Growth (%) 19.1 4.3 23.2 20.5 Operating profit (Rs m) 24,136 27,104 34,597 41,343 PAT (Rs m) 13,070 15,504 19,956 25,121 EPS (Rs) 18.0 21.3 27.4 34.5 Growth (%) 100.3 18.6 28.7 25.9 Net DPS (Rs) 0.4 0.8 1.1 1.4 Q3FY11 Result Update (Rs) 600 500 400 300 200 100 0 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Source: Company Data; PL Research Profitability & Valuation 2010 2011E 2012E 2013E NIM (%)* 5.4 5.2 5.2 5.2 RoAE (%) 18.8 21.1 23.1 23.1 RoAA (%) 2.9 3.0 3.1 3.1 P / BV (x) 3.7 3.1 2.6 2.2 P / ABV (x) 3.7 3.1 2.6 2.2 PE (x) 21.5 18.2 14.1 11.2 Net dividend yield (%) 0.1 0.2 0.3 0.3 Source: Bloomberg Source: Company Data; PL Research *Calculated on average assets Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Valuation and Outlook: Kotak Bank continues to perform well in its lending operations. Outlook for most of its subsidiaries remains largely positive, while the insurance business is likely to take another couple of quarters to consolidate. The post results conference call highlighted management s focus on building capacity for the next phase of growth. The bank, thereby, announced a mid year salary hike to retain talent across group, the benefits of which are likely to accrue in the coming years. This, coupled with higher advertising expenses towards the completion of 25 years, too, affected the overall cost and income dynamics for the bank. We have, therefore, revised our earnings estimates downwards for standalone banking business by 7.2% and 5.6% for FY11 and FY12, respectively. Meanwhile, we have revised our consolidated (ex insurance) earnings by 10.0% and 7.2% for FY11 and FY12, respectively, to factor in the same. We maintain our BUY rating, with a revised price target of Rs531. January 21, 2011 2
Q3FY11 Result Overview (Rs m) Consolidated Y/e March Q3FY11 Q3FY10 YoY gr. (%) Q2FY11 9MFY11 9MFY10 YoY gr. (%) Interest Income 16,538 11,847 39.6 14,493 44,187 33,534 31.8 Interest Expended 7,309 4,449 64.3 6,060 18,602 13,090 42.1 Net Interest Income 9,229 7,398 24.8 8,432 25,585 20,444 25.1 Non Interest Income 10,147 12,058 (15.8) 14,917 35,172 36,872 (4.6) CEB 3,017 3,176 (5.0) 3,213 9,492 9,637 (1.5) Net total Income 19,376 19,456 (0.4) 23,349 60,758 57,316 6.0 Operating Expenses 13,417 13,390 0.2 17,664 43,853 40,590 8.0 Employee 3,967 3,123 27.0 3,732 11,218 9,010 24.5 Policy holders reserves 5,370 6,632 (19.0) 9,928 20,909 21,459 Other operating expenses 4,080 3,635 12.2 4,004 11,726 10,120 15.9 Operating profit 5,959 6,066 (1.8) 5,685 16,904 16,726 1.1 Provisions 534 1,256 (57.5) 474 1,562 3,890 (59.8) Profit before tax 5,425 4,810 12.8 5,210 15,343 12,837 19.5 Tax 1,615 1,480 9.1 1,580 4,705 3,822 23.1 Net Profit after tax (before minority int) 3,810 3,330 14.4 3,631 10,638 9,015 18.0 Less: Share of minority interest 61 50 35 78 64 Add: Share in profit of associates 87 34 45 194 (66) Net Profit after tax (after minority int) 3,836 3,314 15.7 3,641 10,754 8,884 21.0 Asset Quality Gross NPA's 8,637 11,086 (22.1) 9,043 8,637 11,086 (22.1) Gross NPA's % of advances 2.12 3.71 2.37 2.12 3.71 Net NPA's 2,747 5,725 (52.0) 3,320 2,747 5,725 (52.0) Net NPA's % of advances 0.69 1.95 0.88 0.69 1.95 Provision Coverage 68.2 48.4 63.3 68.2 48.4 Gross NPA's % excluding stressed assets 1.49 2.81 1.69 1.49 2.81 Net NPA's % excluding stressed assets 0.51 1.46 0.69 0.51 1.46 Capital Adequacy (%) CAR 18.7 20.5 17.2 18.7 20.5 Tier 1 16.5 18.3 15.7 16.5 18.3 Yield Measurement ratios (%) NIM reported 5.40 6.20 5.60 5.70 6.30 Balance Sheet Items Deposits 261,966 200,830 30.4 264,095 261,966 200,830 30.4 Advances 400,963 293,371 36.7 375,149 400,963 293,371 36.7 Investments 157,690 133,333 18.3 148,729 157,690 133,333 18.3 Total Assets 558,653 426,704 30.9 523,878 558,653 426,704 30.9 January 21, 2011 3
Q3FY11 Result Overview (Rs m) Standalone Y/e March Q3FY11 Q3FY10 YoY gr. (%) Q2FY11 9MFY11 9MFY10 YoY gr. (%) Interest Income 11,354 8,324 36.4 10,147 30,709 23,749 29.3 Interest on Advances 8,784 6,454 36.1 7,761 23,486 18,455 27.3 Income on investments 2,489 1,867 33.3 2,345 7,089 5,284 34.2 Bal with RBI & others 80 3 36.1 41 135 9 27.3 Interest Expense 5,639 3,458 63.1 4,709 14,474 10,428 38.8 Net Interest Income 5,715 4,867 17.4 5,438 16,235 13,321 21.9 Non Interest Income 1,653 1,448 14.2 1,393 4,417 3,767 17.3 Net total Income 7,368 6,314 16.7 6,832 20,652 17,088 20.9 Operating Expenses 4,221 2,945 43.3 3,564 11,084 8,474 30.8 Employee 1,985 1,326 49.7 1,687 5,329 3,818 39.6 Other operating expenses 2,236 1,619 38.1 1,877 5,756 4,656 23.6 Operating profit 3,147 3,369 (6.6) 3,268 9,568 8,614 11.1 Core operating profits 2,084 2,693 (22.6) 2,204 7,585 5,959 27.3 Provisions 427 1,277 (66.6) 455 1,443 3,583 (59.7) Profit before tax 2,721 2,092 30.0 2,812 8,126 5,031 61.5 Tax 842 669 25.9 865 2,431 1,445 68.3 Net Profit after tax 1,879 1,424 31.9 1,947 5,695 3,586 58.8 Asset Quality Gross NPA's 7,442 9,282 (19.8) 7,511 7,442 9,282 (19.8) Gross NPA's % of customer assets 2.53 4.25 2.78 2.53 4.25 Net NPA's 2,353 4,675 (49.7) 2,530 2,353 4,675 (49.7) Net NPA's % of customer assets 0.81 2.18 0.95 0.81 2.18 Provision Coverage 68.4 49.6 66.3 68.4 49.6 Capital Adequacy (%) CAR 18.7 18.3 19.4 18.7 18.3 Tier 1 16.5 16.1 17.2 16.5 16.1 Yield Measurement ratios (%) NIM calculated 5.47 5.99 5.49 5.53 5.94 Balance Sheet Items Deposits 282,880 221,864 27.5 282,870 282,880 221,864 27.5 CASA 78,682 63,052 24.8 90,179 78,682 63,052 24.8 CASA (%) 27.8 28.4 31.9 27.8 28.4 Advances 288,850 214,058 34.9 265,066 288,850 214,058 34.9 Investments 142,867 127,078 12.4 139,352 142,867 127,078 12.4 Total Assets 431,717 341,136 26.6 404,418 431,717 341,136 26.6 January 21, 2011 4
Trend in performance of Kotak Mahindra Bank and its key subsidiaries (Rs m) Y/e March Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Kotak Bank (Standalone) NII 4,365 4,867 5,260 5,082 5,438 5,715 % y o y growth 19.4 27.2 25.8 24.3 24.6 17.4 PAT 1,259 1,424 2,025 1,869 1,947 1,879 % y o y growth 163.0 100.2 97.4 107.0 54.6 31.9 Kotak Mahindra Prime Healthy operating performance; one off operating expenses affect bottomline growth Revenues 2,401 2,546 2,735 2,999 3,158 3,840 % y o y growth (5.5) 7.8 7.4 33.9 31.5 50.8 PAT 395 494 586 760 613 937 % y o y growth 11.6 48.5 24.7 302.1 55.2 89.5 Advances Auto (Rs bn) 55 60 65 71 78 79 Advances Others (Rs bn) 13 14 18 20 22 25 Healthy growth trend in auto advances continues, strong recovery from NPA account boosted bottomline Kotak Mahindra Old Mutual Life Insurance Gross Premium 5,859 7,116 11,371 5,577 7,348 6,108 % y o y growth 11.5 39.1 25.5 28.7 25.4 (14.2) PAT 44 193 444 (69) 134 236 % y o y growth (13.7) 105.6 11.8 (727.3) 204.5 22.1 Revised ULIP guidelines affect gross premium growth; however tighter control over operating costs improves profitability Kotak Mahindra Capital Company Revenues 222 189 382 339 335 306 % y o y growth (31.9) 31.3 324.4 53.4 50.9 61.9 PAT 41 16 134 69 73 76 % y o y growth (53.9) (184.2) (452.6) 42.9 78.0 375.0 Industry outlook has improved and deal pipeline remains strong; bottomline improves marginally despite sequential decline in revenues January 21, 2011 5
Trend in performance of Kotak Mahindra Bank and its key subsidiaries (Rs m) Y/e March Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Kotak Securities Revenues 2,345 1,927 1,872 1,744 1,980 1,957 % y o y growth 7.7 84.4 (4.1) (21.9) (15.6) 1.6 PAT 759 592 508 474 517 466 % y o y growth 85.1 1,380.0 182.2 (36.2) (31.9) (21.3) Average Daily Volumes (Rs bn) 41 38 36 40 46 52 Market Share (%) 4.4 4.2 4.1 3.7 3.7 3.7 Strong sequential traction in volumes continues (13.0% QoQ); market share stable, but revenues and profitability continue to remain under pressure Kotak Mahindra AMC Revenues 481 507 395 375 166 239 % y o y growth 126.9 96.5 55.5 0.5 (65.5) (52.9) PAT 195 229 130 74 (40) 56 % y o y growth NM 281.7 83.1 (46.8) (120.5) (75.5) AUM (Rs bn) 362 414 348 285 284 276 Equity 54 54 49 45 44 40 Debt 308 360 299 240 240 236 AUM's decline QoQ in line with the industry trend; equity AUMs decline sharply by 9.1% QoQ leading to 2.8% QoQ decline in total AUMs Kotak Investment Advisors Limited (KIAL) Revenues 247 245 244 248 221 231 % y o y growth (9.2) (16.9) (18.4) (2.7) (10.5) (5.7) PAT 95 115 71 108 106 54 % y o y growth (18.1) (13.8) (30.4) (8.2) 11.6 (52.9) Commitments (Rs bn) 55 55 1 54 53 53 Revenues remain largely flattish; but profits decline sharply by ~50% both on YoY as well as on a QoQ basis International Subsidiaries AUM (Rs bn) 1.8 1.6 1.6 1.6 2.0 2.0 % y o y growth 20.0 23.1 45.5 11.1 25.0 PAT 208 226 153 157 123 82 % y o y growth 235.5 204.9 705.3 (32.0) (40.9) (63.7) AUMs remain flat QoQ; however higher operating expenses QoQ result in 33.3% QoQ decline in profits January 21, 2011 6
Trend in Consolidated PAT contribution by various subsidiaries Proportion of the lending business to consolidated profits rose significantly to 74% on account of a steep increase in the profitability of Kotak Prime. We expect the lending business to contribute 60 65% to bank s consolidated bottom line in the medium term. In terms of contribution of various subsidiaries towards consolidated bottomline, contribution from the broking and investment banking business remained fairly stable, while that of the life insurance business improved during the quarter. 100% 80% 60% 40% 20% 0% 20% Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 KMB 54% 49% 35% 42% 43% 48% 57% 53% 49% KMAMC 5% 3% 5% 7% 7% 3% 2% 1% 1% KSEC 3% 9% 29% 25% 18% 12% 14% 14% 12% KMCC 1% 2% 2% 1% 0% 3% 2% 2% 2% Intl Subs 6% 1% 9% 7% 7% 4% 5% 3% 2% KMIA 10% 5% 5% 3% 3% 2% 3% 3% 1% KMLI 7% 19% 0% 1% 6% 11% 2% 4% 6% KMP 25% 22% 7% 13% 15% 14% 23% 17% 24% SOTP Valuation Subsidiaries Basis (Rs bn) Multiple KMB Rs. Per share % of SOTP FY12E FY13E FY12E FY13E FY12E FY13E Kotak Securities KSEC Earnings 2.6 3.1 13.0 46 56 10% 10% KMCC KMCC Earnings 0.4 0.5 13.0 7 8 2% 2% Kotak AMC KAMC AUMs 271.4 325.7 4.0% 15 18 3% 3% Pvt Equity KMIA AUMs 80.6 96.7 8.0% 9 11 2% 2% Kotak Prime KMP ABV 14.8 22.2 2.5 51 76 11% 14% Investments KMI ABV 3.1 3.7 1.5 6 8 1% 1% International Subs Earnings 0.6 0.8 13.0 11 13 2% 2% Kotak UK Kotak UK Earnings 0.2 0.3 13.0 4 5 1% 1% Kotak OM Life KMLI* App Value 37.2 44.7 32 39 7% 7% Value of subsidiaries per share 182 234 KM Bank ABV ** 71.5 84.5 2.8 273 323 60% 58% SOTP target price 455 557 100% 100% Source: PL Research 12 month forward price target based on 25% of FY12E & 75% of FY13E price targets above * post 15% holding company discount for its life insurance venture ** ABV reduced by Rs 6 per share for investments in subsidiaries and outstanding NNPAs January 21, 2011 7
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai 400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage % of Total Coverage 60% 50% 40% 30% 20% 10% 0% 54.5% 29.5% 13.6% 2.3% Buy Accumulate Reduce Sell PL s Recommendation Nomenclature BUY : Over 15% Outperformance to Sensex over 12 months Accumulate : Outperformance to Sensex over 12 months Reduce : Underperformance to Sensex over 12 months Sell : Over 15% underperformance to Sensex over 12 months Trading Buy : Over 10% absolute upside in 1 month Trading Sell : Over 10% absolute decline in 1 month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. We may from time to time solicit or perform investment banking or other services for any company mentioned in this document. For Clients / Recipients in United States of America: All materials are furnished courtesy of Direct Access Partners LLC ("DAP") and produced by Prabhudas Lilladher Pvt. Ltd. ("PLI"). This material is for informational purposes only and provided to Qualified and Accredited Investors. You are under no obligation to DAP or PLI for the information provided herein unless agreed to by all of the parties. Additionally, you are prohibited from using the information for any reason or purpose outside its intended use. Any questions should be directed to Gerard Visci at DAP at 212.850.8888. January 21, 2011 8