Fears on NPLs exaggerated; Street is not pricing in RoE improvement post FY18
We upgrade Axis Bank to Buy with a price target of Rs 675. The FY18 credit cost guidance is high enough to absorb NPLs including undisclosed problem loans for a 55% haircut. Improvement in the retail franchise (asset & liability) anchors the current earnings run rate. A return of capex over the next 18 months will boost loan growth, NIM and fee. We expect RoE to normalise to 17-18% by FY19E — not priced in. Credit cost guidance credible: There’s a fear of large NPLs outside of what the bank has disclosed. What is being missed in this line of reasoning is that the credit cost guidance of 2.25% covers for a 55% haircut or loss given default (LGD) on the entire disclosed problem loans (9.3% of gross customer assets).
Retail franchise the cornerstone: Customer acquisition and SME/transaction banking have reported big improvements. Retail fee income and product distribution has seen a steady uptick. The liability side has perhaps benefited the most. With improved product penetration, both transaction activity levels as well as average CASA balances have improved. Change in estimates: We expect 10 bps of NIM compression in FY18, but expect to see progressive 10 bps improvement thereafter. We expect bulk of slippages to come through in FY18 and accordingly, we have raised credit cost assumptions in FY18. These lead to a 24% cut in FY18e and 10-12% increase in FY19/20e EPS estimates.
Valuation/risks: We roll forward to Q1FY19e and value AXSB at 2.5x Jun’18e adj. book value and 14.2x EPS (12m to Jun’19E). The stock trades at 1.9x adj. BV (Jun’17E) and 21.5x EPS (12m to Jun’18e). We believe Street is not pricing in the RoE improvement