Q3FY16 earnings were ahead of expectations at R6.4 bn for the standalone entity, mainly on lower-than-expected credit cost, though overall integration is progressing well with no negative surprises on asset quality.
Highlights: Kotak Mahindra Bank (KMB) is now in the final stages of fully integrating the operations of e-IVB (erstwhile ING Vysya Bank) with itself with the final pieces of technology and organisational structure to be integrated by April/May 2016, in addition to ongoing rationalisation of branches. For the combined entity, loan growth stood at 4% q-o-q driven by 5% q-o-q growth in retail advances, 4% q-o-q growth in corporate advances while agri advances declined 2% q-o-q. Management has been cautious to grow the agri book, given the rural slowdown.
Margins remained stable q-o-q at 4.3% versus earlier standalone KMB margins of 4.7% as synergies are yet to kick in. However, synergies have started to manifest with the increased momentum in SA (savings deposits), growing 31% y-o-y in e-IVB branches and 41% y-o-y in KMB branches. Similarly, traction is also building up in cross-selling fee products to e-IVB customers. On the cost front, KMB has been able to control costs quite well, in line with NII expansion. On the asset quality front, there have been no negative surprises beyond the c6% of e-IVB loans that KMB management had recognised as stressed in 1Q. Unlike the rising asset quality stress in the sector, GNPLs have remained stable at 2.35% and management did not resort to strategic debt restructuring or 5/25 refinance in Q3.
Outlook: Management sounded cautious on growth, given the rising global and domestic stresses in the past few months. However, with a strong balance sheet and ample capital, it would be looking to ‘cherry pick’ quality loan accounts to grow and increase market share at the cost of PSU Banks that are reeling under asset quality stress. We continue to expect KMB to deliver an earnings CAGR of over 40% and RoA to improve to 1.75% by FY18e.
Retain Hold: KMB (standalone) trades at 3.7x 12-month forward AB. We continue to value the stock at 3.8x, giving us a value of Rs 512. Adding Rs 154 for the value of the subsidiaries, we arrive at a fair value of Rs 666. Upside risk: Much better-than-expected merger synergies; Downside risk: Under-estimated integration challenges.
Valuation and risks
We value Kotak Mahindra Bank stock using a single stage Gordon growth model based on a weighted average ROE of 21.3% (unchanged). We maintain a growth rate of 10%, cost of equity of 13% (based on 7.5% risk free rate, 5% risk premium and 1.1 beta), leading to a justified P/AB multiple of 3.8x (unchanged).