Re-rating ahead

Updated: Oct 6 2014, 10:36am hrs
We believe Axis Bank stock could be a doubler in three years and could potentially touch 900 more than 100% return, including dividends. This is driven by a strong compounding effect we expect book value CAGR (compound annual growth rate) to be 18% over FY14-FY19e. We also expect P/B (price-to-book) multiples to expand from the current 1.9x to 2.5x over the next few years due to the banks solid earnings growth, return metrics and bridging of the fundamental gap with its peers. Our earnings are marginally above consensus and consensus has been upgrading earnings steadily. We expect valuation multiples to expand, going ahead.

We are increasing our EPS (earnings per share) estimates for FY15e-FY17e by 8% driven by lower credit costs and operating expenses. We are now more comfortable on Axis Banks ability to manage credit quality as the loan book is more diversified and risks are lower. We expect cost efficiencies to be preserved as the bank continues to reap scale benefits. We increase our TP (target price) by 8% to R500 driven by higher RoE (return on equity) and hence higher TP multiple (P/BVprice to book value-- increased from 2.3x to 2.5x).

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The biggest advantage is that Axis Bank over the years has consciously tried to diversify its funding mix with more focus on retail deposits. The share of bulk/ wholesale deposits has come down from 41% in FY11 to 23% in Q1FY15 and that has lent more stability to margins, which is impressive. NIMs (net interest margins) today have been kept sustainably at 3.5% levels. We think worries over the asset side of the balance sheet are exaggerated. The share of retail book increased from 19% in FY11 to 32% in Q1FY15. We also note that exposure to the power sector and to leveraged groups has been coming down. Despite excessive worries over credit quality by the market, credit costs have been contained at 100bps. We believe credit costs over the next few years will normalise around 80bps.

With CET1 (common equity tier 1) at 12.5%+, daily average CASA (current account savings account) steadily improving and at 40% now, the bank is very well capitalised and has an excellent deposit franchise. ROA (return on assets) has been steadily improving from 1.07% seen in FY07 to 1.7% in FY14 and we expect ROAs to touch 1.8% over the next couple of years. ROEs eventually could cross 20% by FY18e. ROAs and RoEs are actually as good as its more expensive retail peers. However we do take into account that Axis has a larger restructured assets book which we have adequately captured in our valuations. Valuation gap should narrow with respect to peers.

Axis Bank now trades at a 35% discount to the retail private sector peers and at its historic averages. We believe with an improving earnings growth trajectory and Axis bridging the gap with respect to its peers plus a sustainable improvement in overall fundamentals, the valuation gap should narrow and expect the stock to re-rate.

We value the stock at 2.5x P/BV which still represents a 20% discount to HDFC Banks valuation and 40% lower than previous highs. We expect the EPS CAGR for Axis Bank to be 20% over the next three years and we clearly see a convergence to its higher valued retail peers happening with respect to EPS, ROA and ROE. As the gap in fundamentals is bridged, we expect the stock to re-rate from 1.9x currently to 2.5x over the next few years.

Macquarie