Right fit Right price; significant synergies in long term! November 21, 2014 Nitin Kumar nitinkumar@plindia.com +91 22 66322236 Pritesh Bumb priteshbumb@plindia.com +91 22 66322232 Rating Accumulate Price Rs1,157 Target Price Rs1,250 Implied Upside 8.0% Sensex 28,068 Nifty 8,402 (Prices as on November 20, 2014) Trading data Market Cap. (Rs bn) 856.8 Shares o/s (m) 740.7 3M Avg. Daily value (Rs m) 2064 Major shareholders Promoters 40.07% Foreign 34.61% Domestic Inst. 2.01% Public & Other 23.31% Stock Performance (%) 1M 6M 12M Absolute 15.2 28.1 57.8 Relative 9.0 12.9 21.8 How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2015 33.9 39.6 14.4 2016 40.6 48.7 16.6 Price Performance (RIC: KTKM.BO, BB: KMB IN) (Rs) 1,400 1,200 1,000 800 600 400 200 0 Nov 13 Jan 14 Source: Bloomberg Mar 14 May 14 Jul 14 Sep 14 Nov 14 We believe that merger with VYSB IN is a good fit for KMB IN and will help the latter in further increasing its outreach. ING Vysya bank has a strong liability profile, robust SME portfolio (35% of loans) which KMB lacks currently (9% of loans, and has aspiration to build) and minimal geographical branch overlap with KMB. VYSB IN also has an attractive liability franchise with a CASA mix of 33% (similar to KMB IN). We believe that deal is priced quite reasonably (KMB IN has got a good deal) at ~1.8x Sep FY16E ABV, particularly seen in the context of past mergers. We believe that strong experience of KMB management in handling stressed accounts will help tide over the asset quality issues (perceived at VYSB IN) and moreover since the economy is likely on an uptick the risks may turn out to be lower than expected. We maintain our Accumulate rating on KMB IN with a revised PT of Rs1,250 keeping target multiple unchanged at 3.6x Sep 16E ABV. Merger Concall Highlights Synergies: Branches KMB will get diverse geographic presence as KMB is strong in North and West while VYSB has strong presence in South India. VYSB also has 170 branches in Andhra & Telangana which will be significant opportunity for growing business in the state. This will also ensure that regulatory hurdles remain limited. Metro branch presence also fits in the strategy for KMB especially in cities like Bangalore, Hyderabad, Kolkata etc., where KMB s presence was low and had always planned to expand organically in these cities. Products & Branches KMB has better footing on certain products like tractors, which can be used to sell through VYSB branch network in South. Also other products like CV/CE & Consumer finance (VYSB is weak in consumer finance products). Alternately VYSB brings along a robust SME franchise which KMB has been keen to build. Contd...2 Key financials ( Y/e March) 2013 2014 2015E 2016E Net interest income (Rs m) 41,689 48,382 53,276 62,980 Growth (%) 21.4 16.1 10.1 18.2 Operating profit (Rs m) 31,565 37,669 42,472 50,590 PAT (Rs m) 19,909 22,859 26,663 31,982 EPS (Rs) 26.7 29.0 33.9 40.6 Growth (%) 8.9 16.6 19.9 Net DPS (Rs) 0.7 0.8 0.9 1.1 Profitability & Valuation 2013 2014 2015E 2016E NIM (%) 4.45 4.50 4.49 4.47 RoAE (%) 14.4 13.7 13.6 14.4 RoAA (%) 2.13 2.13 2.25 2.27 P / BV (x) 5.8 4.9 4.4 3.8 P / ABV (x) 5.9 5.0 4.5 3.9 PE (x) 43.4 39.8 34.2 28.5 Net dividend yield (%) 0.1 0.1 0.1 0.1 Source: Company Data; PL Research Event Update 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
Outlook & Rationale: Have taken this merger as significant product and revenue synergy was present. KMB has strong products especially from existing subs like insurance, capital market etc, which will help market to VYSB customers and be a advantage to subsidiaries businesses. KMB will not pause on branch expansion but will be going very selective on expansion and will be strategizing to fill the gaps for presence. Synergies: Branches Will double branches to 1214 from 635 branches and will get diverse geographic presence as KMB is strong in West and VYSB has strong presence in South India. VYSB also has 170 branches in Andhra & Telangana which will be significant opportunity for growing business in the state. Branches overlap is low so helps diverse presence for KMB and also regulatory hurdles also will be limited. Metro branch presence also fits in the strategy for KMB especially in cities like Bangalore, Hyderabad, Kolkata etc., where KMB s presence was low and had always planned to expand organically in these cities if merger was not done. Products & Branches KMB has some better footing on certain products like tractors, which can be used to sell through VYSB branch network in South. Also other products like CV/CE & Consumer finance (VYSB is weak in consumer finance products). International relationship VYSB has build up international clients business with help of ING (Parent of VYSB), which will help also KMB to build international presence and relationships. Liabilities KMB can grow a strong CA profile on back of VYSB s strong SME presence, and this will turn an advantage to build both SME & CA (VYSB has 1.2% market share in CA and KMB has 1.4%). Technology ING Inc has significant digital penetration in Europe and has helped VYSB to build digital platform in India, which can be value add to KMB existing digital platform. Customers KMB S lone has customer base is ~4 5 million and with combined entity customer base will increase to ~10 million. November 21, 2014 2
Shareholding: KMB s promoter holding will reduce to 34% after the merger goes through (RBI has mandated to reduce promoter holding below 30% by Mar 16, also ING s stake was +40% which was above comfort level of RBI). ING Groep will be the second largest share holder with 6.5% stake, which will have one year lock in period (subject to approval). According to management, foreign bank can hold upto 10% in Indian bank, which has no branch presence in India and subject to RBI approval (can hold upto 5% in any bank if foreign bank has branch presence in India). Management & Employees: Uday Sareen (CEO designate of VYSB) will stay with KMB operating management and bring in expertise on both SME & consumer business. KMB has 29,220 employees and VYSB has 10,591 employees of which 3,000 are union employees. Will retain the existing terms for Union employees on pension & wage related provisions as they come under IBA, but will leave on the Union employees if they want to convert on KMB s wage terms. Challenges: Technology integration will be solved over time, have already started integration process and have sufficient time to integrate the systems. But both systems are high class so will not be a issue to integrate. KMB believes they will pass regulatory hurdles smoothly. Will have to take approvals from RBI, CCI and Judiciary. Asset quality issues will be taken head on if there are any. November 21, 2014 3
Exhibit 1: Pro forma earnings for the merged entity. Kotak ING Vysya Merged Kotak ING Vysya Bank Financials (Rs M) entity FY14 FY15E FY16E FY14 FY15E FY16E FY15E FY16E Equity capital 3,937 3,937 3,937 1,886 1,886 1,886 4,548 4,548 Reserves 182,240 202,445 232,844 67,801 73,524 81,295 277,244 315,415 Net worth 186,177 206,382 236,781 69,687 75,410 83,181 281,792 319,962 Savings deposits 100,870 125,675 161,968 67,508 79,832 97,083 205,507 259,051 Current deposits 87,410 105,028 135,130 70,079 82,604 100,132 187,631 235,262 Term deposits 402,443 474,318 603,942 274,581 320,555 384,862 794,873 988,803 Total deposits 590,723 705,021 901,040 412,168 482,991 582,076 1,188,012 1,483,116 Borrowings 266,973 280,770 337,770 84,747 91,168 103,563 371,938 441,333 Other liabilities 58,009 62,535 75,224 24,566 22,961 27,975 85,496 103,200 Total 1,108,849 1,261,675 1,557,782 603,106 688,469 816,733 1,950,143 2,374,516 ASSETS Loans 741,079 831,976 1,021,824 358,289 422,780 507,337 1,254,757 1,529,161 Corp investments 46,349 56,545 70,681 8,724 8,724 8,725 65,270 79,406 Gilts 177,747 209,232 268,193 104,975 124,032 151,118 333,264 419,311 Cash/equiv 81,826 92,280 115,156 58,261 60,811 74,091 153,091 189,247 Total 1,108,849 1,261,675 1,557,782 603,102 688,469 816,733 1,950,143 2,374,516 Deposit growth 15.8% 19.3% 27.8% 0.3% 17.2% 20.5% 18.5% 24.8% Credit growth 10.1% 12.8% 23.0% 14.5% 17.6% 19.6% 14.1% 21.9% C D ratio 125.5% 118.0% 113.4% 89.0% 89.3% 88.7% 105.6% 103.1% CASA Ratio 31.9% 32.7% 33.0% 33.4% 33.6% 33.9% 33.1% 33.3% Gross NPA 10,594 12,200 14,706 6,442 9,352 10,642 21,552 25,348 Net NPA 5,736 6,100 7,353 1,020 2,057 2,661 8,157 10,013 Gross NPA ratio 1.55% 1.61% 1.58% 1.77% 2.17% 2.07% 1.72% 1.66% Net NPA ratio 0.85% 0.80% 0.79% 0.28% 0.49% 0.52% 0.65% 0.65% Provision coverage 45.4% 50.0% 50.0% 83.9% 77.6% 74.6% 62.1% 60.5% CAR 19.0% 18.5% 16.9% 16.8% 16.0% 15.1% 17.1% 15.7% Tier 1 17.8% 17.4% 16.1% 14.6% 13.4% 12.4% 16.1% 14.8% RWAs 661,351 773,781 967,226 469,089 553,525 664,230 1,327,306 1,631,456 Contd...5 November 21, 2014 4
(Rs M) Profit and Loss Summary Kotak ING Vysya Merged Kotak ING Vysya Bank entity FY14 FY15E FY16E FY14 FY15E FY16E FY15E FY16E Interest Income 114,357 126,295 148,394 52,052 57,906 67,134 184,200 215,528 Interest expenses 65,974 73,019 85,414 34,521 37,955 43,815 110,974 129,229 Net Interest Income 48,382 53,276 62,980 17,532 19,951 23,319 73,226 86,299 Fees 22,417 27,028 31,979 8,109 9,244 10,908 36,273 42,887 Net revenues 70,799 80,304 94,959 25,640 29,195 34,227 109,499 129,187 Operating Expense 35,190 39,632 46,169 14,927 15,786 17,887 55,419 64,055 Employee exp 15,506 16,836 19,440 9,034 9,197 10,432 26,034 29,872 Other opex 19,684 22,796 26,728 5,893 6,589 7,455 29,385 34,183 Operating profit 35,609 40,672 48,790 10,713 13,408 16,341 54,080 65,131 Investment profits 2,060 1,800 1,800 562 550 600 2,350 2,400 Preprovision profit 37,669 42,472 50,590 11,275 13,958 16,941 56,430 67,531 Provisions 3,282 2,779 2,982 1,498 3,421 2,419 6,200 5,401 Loan loss provisions 1,632 2,778 2,981 1,172 3,421 2,419 6,199 5,400 PBT 34,387 39,693 47,608 9,778 10,537 14,522 50,230 62,130 Taxes 11,529 13,029 15,626 3,199 3,372 4,792 16,401 20,418 PAT 22,859 26,663 31,982 6,579 7,165 9,729 33,829 41,712 Ratios NII growth 16.1% 10.1% 18.2% 13.9% 13.8% 16.9% 11.1% 17.9% Fees growth 15.2% 20.6% 18.3% 16.5% 14.0% 18.0% 18.8% 18.2% OP growth 19.0% 14.2% 20.0% 11.4% 25.2% 21.9% 13.5% 18.0% PPP growth 19.3% 12.7% 19.1% 13.6% 23.8% 21.4% 10.6% 15.6% Opex growth 12.7% 12.6% 16.5% 17.3% 5.8% 13.3% 6.1% 14.7% PAT growth 14.8% 16.6% 19.9% 7.3% 8.9% 35.8% 14.9% 16.3% Core Cost Income 48.3% 48.3% 47.7% 57.0% 53.1% 51.4% 49.5% 48.7% Tax rate 33.5% 32.8% 32.8% 32.7% 32.0% 33.0% 32.7% 32.9% November 21, 2014 5
Exhibit 2: ROA decomposition RoA tree for the merged entity Kotak ING Vysya Merged Kotak ING Vysya Bank entity FY14 FY15E FY16E FY14 FY15E FY16E FY15E FY16E Net Interest Income/Assets 4.64% 4.65% 4.63% 3.15% 3.18% 3.18% 4.13% 4.12% Fees/Assets 2.15% 2.36% 2.35% 1.46% 1.47% 1.49% 2.05% 2.05% Investment profits/assets 0.20% 0.16% 0.13% 0.10% 0.09% 0.08% 0.13% 0.11% Net revenues/assets 6.99% 7.17% 7.12% 4.71% 4.75% 4.76% 6.31% 6.29% Operating Expense/Assets 3.38% 3.46% 3.40% 2.68% 2.52% 2.44% 3.13% 3.06% Provisions/Assets 0.31% 0.24% 0.22% 0.27% 0.55% 0.33% 0.35% 0.26% Taxes/Assets 1.11% 1.14% 1.15% 0.58% 0.54% 0.65% 0.93% 0.98% Total Costs/Assets 4.80% 4.84% 4.76% 3.53% 3.60% 3.43% 4.40% 4.30% ROA 2.19% 2.33% 2.35% 1.18% 1.14% 1.33% 1.91% 1.99% Equity/Assets 16.06% 17.14% 16.29% 10.33% 11.57% 10.83% 15.17% 14.38% ROE 13.7% 13.6% 14.4% 11.4% 9.9% 12.3% 12.6% 13.9% Core PPOP / Assets 3.4% 3.6% 3.6% 1.9% 2.1% 2.2% 3.1% 3.1% RORWA 3.46% 3.45% 3.31% 1.47% 1.40% 1.60% 2.55% 2.56% Credit Cost 0.23% 0.35% 0.32% 0.35% 0.88% 0.52% 0.53% 0.39% EPS (Rs) 29.0 33.9 40.6 34.9 38.0 51.6 37.2 45.9 EPS growth (%) 8.9% 16.6% 19.9% 11.9% 8.9% 35.8% 23.3% Book value (Rs) 236.5 262.1 300.7 369.4 399.8 441.0 309.8 351.8 Adjusted Book Value (Rs) 231.2 256.7 294.2 369.1 396.3 435.3 303.6 344.1 ABV Growth (%) 11.0% 14.6% 7.4% 9.8% 13.4% P/E (x) Merged Entity 30.9 25.1 P/ABV (x) Merged Entity 3.8 3.3 Exhibit 3: We increase our TP to Rs1250 based on the merged entity Mar 16 ABV of 344 which implies our TP at 3.6x (Lending business value at 3.3x) Total Subsidiary valuation 148 Lending business valuation (3.6x Mar 16 book) 1,102 Sep 15 PT 1,250 Implied Valuations for Lending business Current Price 1,225 Lending business Implied value 915 Lending business Sep 16 book 324 Implied P/B (Sep 16) 3.32 November 21, 2014 6
Exhibit 4: KMB had more presence towards metro & urban branches Semi Urban 19% Rural 9% KMB Metro 48% Exhibit 5: VYSB had presence decent presence in Semi urban & rural Vysya Rural 15% Metro 35% Semi Urban 18% Urban 24% Urban 32% Exhibit 6: KMB had high presence in North & West, while VYSB had significant presence in South which will now be balanced Exhibit 7: KMB & VYSB complement each other in terms of city presence 100% 80% 60% 40% 20% 0% West North South East 5% 4% 5% 15% 38% 34% 64% 27% 46% 20% 30% 12% KMB VSYB KMB VYSB 140 120 100 80 60 40 20 0 VSYB KMB KMB VYSB Mumbai Delhi B'lore Hydbad Chennai Kolkata Exhibit 8: Combined entity market share for both CA and SA will increase especially on CA where both have strong relationships 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% CA Market Share SA Market Share 0.88% 0.53% 0.35% 2.60% 1.44% 1.16% KMB Vysya KMB VYSB November 21, 2014 7
Exhibit 9: Historical trend of mergers in the banking sector valuations of the deal doesn t appear expensive specially when seen in historical context Date Mergers Acquisition Value (Rs M) As % of Deposits As % of NW (x) 26 Nov 99 HDFC Bank Times bank 2,190 7% 1.28 11 Dec 00 ICICI Bank Bank of Madura 3,420 9% 1.38 13 Aug 04 Oriental bank Global Trust bank 8,600 12% 352.60 20 Jun 05 Centurion bank Bank of punjab 3,510 8% 1.90 12 Sep 06 IDBI bank United Western Bank 1,505 2% 0.72 10 Dec 06 ICICI bank Sangli bank 3,020 15% 12.08 25 Feb 08 HDFC Bank Centurion Bank of Punjab 95,000 64% 6.80 18 May 10 ICICI Bank Bank of Rajasthan 30,350 20% 3.24 FY2015 Kotak Mahindra Bank ING Vysya Bank 152,400 34% 2.05 November 21, 2014 8
Income Statement (Rs m) Int. Earned from Adv. 85,142 93,434 105,165 123,189 Int. Earned from Invt. 18,698 20,500 20,707 24,782 Others 266 423 423 423 Total Interest Income 104,106 114,357 126,295 148,394 Interest expense 62,417 65,974 73,019 85,414 NII 41,689 48,382 53,276 62,980 Growth (%) 21.4 16.1 10.1 18.2 Treasury Income 1,652 2,060 1,800 1,800 NTNII 19,462 22,417 27,028 31,979 Non Interest Income 21,114 24,477 28,828 33,779 Total Income 125,219 138,833 155,123 182,173 Growth (%) 23.2 10.9 11.7 17.4 Operating Expense 31,238 35,190 39,632 46,169 Operating Profit 31,565 37,669 42,472 50,590 Growth (%) 19.8 19.3 12.7 19.1 NPA Provisions 2,166 1,632 2,778 2,981 Investment Provisions (88) 1,844 Total Provisions 2,093 3,282 2,779 2,982 PBT 29,472 34,387 39,693 47,608 Tax Provisions 9,562 11,529 13,029 15,626 Effective Tax Rate (%) 32.4 33.5 32.8 32.8 PAT 19,909 22,859 26,663 31,982 Growth (%) 15.7 14.8 16.6 19.9 Balance Sheet (Rs m) Par Value 5 5 5 6 No. of equity shares 747 787 787 656 Equity 3,733 3,937 3,937 3,937 Networth 148,465 186,177 206,382 236,781 Adj. Networth 144,504 179,881 199,702 228,703 Deposits 510,288 590,723 705,021 901,040 Growth (%) 32.4 15.8 19.3 27.8 Low Cost deposits 149,183 188,280 230,702 297,098 % of total deposits 29.2 31.9 32.7 33.0 Total Liabilities 1,041,495 1,108,849 1,261,675 1,557,782 Net Advances 672,989 741,079 831,976 1,021,824 Growth (%) 24.7 10.1 12.3 22.8 Investments 284,884 250,995 292,676 365,773 Total Assets 1,041,495 1,108,849 1,261,675 1,557,782. Quarterly Financials (Rs m) Y/e March Q3FY14 Q4FY14 Q1FY15 Q2FY15 Interest Income 21,923 22,125 22,864 23,525 Interest Expense 12,796 12,459 12,842 13,136 Net Interest Income 9,127 9,665 10,022 10,389 Non Interest Income 2,997 3,405 3,998 4,665 CEB Treasury Net Total Income 12,125 13,070 14,020 15,054 Operating Expenses 6,277 6,999 7,364 7,717 Employee Expenses 2,773 3,157 3,484 3,545 Other Expenses 3,504 3,843 3,880 4,172 Operating Profit 5,847 6,071 6,655 7,336 Core Operating Profit 5,847 6,071 6,655 7,336 Provisions 697 (62) 140 537 Loan loss provisions Investment Depreciation Profit before tax 5,150 6,133 6,515 6,800 Tax 1,750 2,061 2,217 2,355 PAT before EO 3,400 4,072 4,298 4,445 Extraordinary item PAT 3,400 4,072 4,298 4,445 Key Ratios CMP (Rs) 1,157 1,157 1,157 1,157 Equity Shrs. Os. (m) 747 787 787 656 Market Cap (Rs m) 863,603 910,762 910,762 758,969 M/Cap to AUM (%) 82.9 82.1 72.2 48.7 EPS (Rs) 26.7 29.0 33.9 40.6 Book Value (Rs) 199 236 262 301 Adj. BV (75%) (Rs) 196 231 257 294 P/E (x) 43.4 39.8 34.2 28.5 P/BV (x) 5.8 4.9 4.4 3.8 P/ABV (x) 5.9 5.0 4.5 3.9 DPS (Rs) 0.7 0.8 0.9 1.1 Dividend Yield (%) 0.1 0.1 0.1 0.1 Profitability (%) NIM 4.5 4.5 4.5 4.5 RoAA 2.1 2.1 2.2 2.3 RoAE 14.4 13.7 13.6 14.4 Efficiency Cost Income Ratio (%) 49.7 48.3 48.3 47.7 C D Ratio (%) 131.9 125.5 118.0 113.4 Business per Emp. (Rs m) 85 83 84 91 Profit per Emp. (Rs lacs) 14.3 14.3 14.5 15.1 Business per Branch (Rs m) 2,787 2,728 2,738 2,978 Profit per Branch (Rs m) 47 47 47 50 Asset Quality Gross NPAs (Rs m) 8,295 11,523 13,360 16,156 Net NPAs (Rs m) 3,961 6,296 6,680 8,078 Gr. NPAs to Gross Adv. (%) 1.2 1.6 1.6 1.6 Net NPAs to Net Adv. (%) 0.6 0.8 0.8 0.8 NPA Coverage (%) 52.2 45.4 50.0 50.0. November 21, 2014 9
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% 49.5% 32.7% 16.8% 0.9% 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. November 21, 2014 10