We downgrade IndusInd Bank to Hold with a revised price target of R1,150. While earnings could grow 24% CAGR FY16-19e, both sustainability & volatility of some of the underlying revenue streams driven by non-traditional products need to be closely seen. We are hamstrung by lack of data in making profitability judgements, but we think according similar multiples for all revenue/profit streams is a stretch. Valuations are full at 3.2x fwd book.
NIM at life high, see downside
Bulk of the NIM improvement in FY16 has come from lower fund costs, as yield in corporate book declined & consumer book held owing to higher CV disbursals but is cyclical. However, a narrowed structural funding gap – hard to decipher the impact from LCR regulation — could protect NIM to some extent. Deposit accretion seems soft.
Non-interest income contribution up; too volatile to decipher
Non-interest income drives 42%+ of revenue (core fee contribution at 36%). Exchange income – of which 3/4th is core & balance comes through ‘trading’ where RoEs are very high – drives the improvement. Non-traditional fee like ‘Investment banking’ contribution has increased. However, ‘Distribution fee’ has weakened with bancassurance business slowing down, offset by card and home loan distribution. ‘Loan processing fee’ is the most volatile of the lot with limited correlation to disbursal or loan growth based on available data.
A higher Opex demands better NIM/fee
IIB runs a very high opex model driven by consumer loan orientation. On comparative basis, the business seems to have become a bit heavy from investment perspective and hence the need to deliver higher NIM/fee is crucial for maintaining profitability.
Higher vehicle disbursals & lower repayment drives consumer loans; non-retail composition shifts towards term loans.
Vehicle loans were half of disbursals in FY16, grew 50%+ and coupled with falling repayment rates (43% vs 48% last year) helped consumer loans grow 29%. The share of term loans in non-retail book has been increasing and is at 54% of this book. It’s pertinent to note that IIB classifies most of the agri & inclusive business as non-retail, which should be largely working-capital financing.
IIB trades at 3.7x trailing P/B (Jun 16E) & 21.8x P/E (12m to Jun 17E). We value IIB at 3.3x trailing P/B (Jun 17E) & 17.6x P/E (12m to Jun 18E). Comparative five-year average is 3.2x/16.1x respectively.
Valuation not cheap – not all revenue streams are created equal
In an NPA scorched space, IIB is among few banks that have managed to deliver strong EPS growth and remained relatively unscathed from NPAs. This has led to higher investor positioning in the stock as evidenced by premium valuation multiples.
While the business model is strong and could generate 24% earnings CAGR over FY16-19e, some of the revenue lines need to be looked at more closely to account for the volatility and sustainability in the longer run. At current valuation multiples, we are not willing to punch in higher numbers to justify a Buy recommendation. We see the stock being at best a market performer in the near term.
Strong outperformance justifies a breather
IIB has also outperformed the broader market and its peers. While the stock is up 32% in the last 12 months, the broader banking index BANKEX is up a mere 2%.
No material change in estimates: We update our model for the annual numbers and make negligible change to our earnings estimate.
IIB trades at 3.7x trailing P/B (Jun 16E) & 21.8x P/E (12m to Jun 17E). We value IIB at 3.3x trailing P/B (Jun 17E) and 17.6x P/E (12m to Jun 18E). Comparative 5 year avg. is 3.2x/16.1x respectively. Risks: Up— Loan growth; Down — Loan & fee slowdown, asset quality deterioration.
We value IIB using an equal-weighted triangulation approach of price-to-book (using cross cycle RoE), historical price-to-earnings multiple and residual income model. We use risk-free rate of 7.5%, beta of 1.2 and market premia at 4.5%.
We find HDFC Bank (HDFCB IN, Buy, R1,165), which is closest in terms of IIB’s business model, to be trading around its historical valuation multiples for better RoE profile, and only slightly higher valuation multiple on like-to-like basis.
NIM at life high, see downside
FY16 saw the NIM expand 15 bps to 3.8% versus 3.65% in FY15. Bulk of the NIM improvement has come by better management of cost of funds. Nevertheless, the disbursal and loan mix change towards CV loans have helped offset the drop in yield of advances in both the corporate and balance of the retail portfolio. While CV loans could continue to dominate the disbursals — it’s cyclical, and we believe the drop in yields in the rest of the portfolio would put pressure on the NIM at the margin.