Maintain Yes Bank at overweight, price target raised by Rs.175

Updated: Jan 18 2013, 08:34am hrs
We maintain our overweight rating on Yes Bank and arrive at our new price target of R675 (R500 earlier) using a probability-weighted residual income model, a five-year high growth period, a 10-year maturity period, followed by a declining period. At the new target, the stock would be trading at 12.9x our FY15e earnings and 2.5x FY15e book, which we find fairly attractive for a bank growing as fast as Yes Bank is.

The increase in our target price is driven by a change in probability weights and change in scenario values. We have raised our scenario as follows. Base-case value by 30% to R675. Bear-case value by 30% to R435, and bull-case value by 30% to R835 all driven by a combination of higher earnings, book value accretion on account of proposed capital issuance, and lower cost of equity. We have increased our earnings estimates by 8.2% for FY13, 12.0% for FY14 and 12.5% for FY15, mainly on the back of higher revenues (higher NIMs, volumes and fee income).

Our view on Yes Bank has been that this is a fast growing and very well run bank in nascent stages of growth. Historically, this has been the best time to own Indian private banks earnings growth is strong (and usually continues to surprise on the upside) and multiples are picking up. We have expected similar trends at Yes, and these are underway. After the 39% CAGR in loans seen in the last five years, Yes still has only 0.8% of system loans implying a few more years of strong growth ahead.

Given the intense competition for deposits and savings account, deposit growth at Yes Bank was fairly tepid until last year. However, the savings account rate deregulation has been a huge benefit for the bank. While its rates are materially higher than those of larger banks and marginally below 7%, this situation is much better than borrowing from fixed deposits at around 9%. Every savings account deposit raised helps Yes Banks NIMs by almost 2% (incrementally). The bank has shown robust growth in savings account balances, and as distribution picks up (targeting 900 branches by FY15 from the current 412), savings account balances should rise further.

In addition, Yes Bank has managed asset quality exceptionally well. Its impaired loan balances (NPL + restructured) have remained very low at just around 0.6%. This has been helped by more cautious underwriting and collateralisation. The bank has now gone through two periods when Indian banks faced credit cycles (2008-09 and 2011-present), and in both cycles it has managed its asset quality very well.

Morgan Stanley