Surge in margins

Updated: Oct 31 2011, 06:18am hrs
Axis Banks Q2FY12 PAT (profit after tax) of R9.2 bn (up 25% year-on-year) was largely in line with our estimate. During the quarter, core income came to the fore; NIMs (net interest margins) were up by a scorching 50 bps (basis points) quarter-on-quarter to 3.78% and fee income growth was at an impressive 32%. Sequential slippages picked up to 1.4% (1% in Q1FY11) though well within our estimates of 1.5%. We maintain a Buy recommendation with a target price of R1,450 (2.5x--times--rolling 1-year forward, translating to 25% discount to HDFC Bank against the current 50%), offering an upside of 30%.

Led by strong re-pricing of advances (base rate hike), stable cost of funds (reflecting full re-pricing of wholesale deposits and higher average CASAcurrent accounts, savings accounts-balances) and a change in mix (rundown of low-yielding agri-portfolio) led to a robust surge in margins by 50 bps q-o-q to 3.78%well above the upper end of its guided range of 3.5%. The higher yield on investment by 12 bps also supported NIMs. Despite the improvement, the management is sticking to its long-term guidance of 3.25%-3.5%, suggesting that it will utilise the gain to capitalise on growth opportunities (including building up current years PSL-priority sector lendingobligation) hence putting downside risk to lending yield as against increase in cost of funds.

Led by a stable margin and fee income performance coupled with benign asset quality (against the consensus expectation), we anticipate Axis Bank to deliver a healthy 20% earnings CAGR (compound annual growth rate) over FY11-13e (estimate). The banks strategy of moderating the pace of loan growth will enable it to build a more formidable retail franchise and achieve consistently higher RoA (return on assets). We believe it can sustain higher RoA of 1.5%-1.6% against 1%- 1.2% a few years ago, allowing RoE (return on equity) to move closer to 20% in a capital efficient manner. As Axis Bank delivers consistent earnings, we expect the current valuation discount of 25% to HDFC Bank to come off to 50%. The stock is attractive at 1.8x-times-FY13e adjusted book and 9.6x FY13e earnings. We maintain Buy and rate it Sector Outperformer on relative returns. Axis Bank continues to be one of our top picks in the space.

Led by a stress on SMEs (small & medium enterprises), agri and mid-corporates, slippages inched up during the quarter to R5 bn (1.4% annualised)higher than the lower-than-average run-rate of 1% in Q1. The management is sticking to its guidance of about 1%, slippages translating to about 75 bps of credit cost. We believe that the Street is already building in a much higher slippage number of 1.5% and credit cost of about 105 bps. Over the last couple of years, Axis Bank had been leveraging its improving liability franchise and strong pricing power to increase the exposure to large corporate segment with a minimal impact on margins.

Contrary to the previous cycle, over the past eight quarters, the bank has improved its share of large corporates (57%) from 48% hence we expect slippages to remain benign. Led by write-offs and recoveries/upgrades of R2.8 bn, the increase in GNPL (gross non-performing loan) was restricted to 1.08% (up a marginal 2 bps q-o-q). Provisioning coverage continues to stand at an impressive 80%including technical write-offs. During the quarter, fresh restructuring was at R3.1 bn (out of which R2.3 bn was in MFImicrofinance institutions), taking the total outstanding restructured book to R24 bn.

After declining in Q1, advance growth picked up in during the quarter (6% q-o-q, 27% y-o-y), led by a steady growth in large corporates of 25%, ably supported by retail assets of 40%which offset the scheduled rundown of the agriculture book. The management reiterated its guidance of growing by about 5% higher than the industry levels, hinting at a tall asking rate of 10% for the next two quarters. As mentioned earlier, we believe that the management would utilise higher margin advantage to capitalise on growth opportunities while pick-up in PSL assets could help make the target achievable. CASA balances during the quarter improved by 200 bps to 42%.

Daily average CASA balances also improved 150 bps to 38.3%, proving to be an able ally for margin improvement. Sectoral split of exposure still suggests that the non-fund based exposure to the power sector is high at 17% though as highlighted in our note 'Much ado about Power dated the 3rd August 2011', the exposure is overstated as Axis being a consortium leader fronts the LC (letter of credit) opening guarantees for the other consortium members. As and when the non-fund exposure crystallises into fund based exposure, Axis Banks share will be restricted to its contribution of 15%-20%.

Once again, the diversified income platform came out strong with the fee growing at 32% (37% of net revenues). As expected, the normalisation in corporate banking took place (growth tapering off to 27% from 81% in Q1). Retail banking fees once again grew at an impressive pace of 39% y-o-y with the benefit coming from a smaller base during Q2FY11 (the bank exited bancassurance tie-up with Metlife). Treasury and DCM (debt capital market) segment also grew strongly by 48% on the back of firm forex revenues and syndication activities. Dependence on trading profits further declined to 1% from 3% in FY11 as the trading loss in the equity book of R280 m offset theR424 m profit in the forex and derivatives trading.