Axis bank is nearing the end of the last credit recognition cycle and the business model is much more granular than it has ever been. We expect 20% PPOP CAGR over FY18-21F driven by 16-17% loan growth CAGR and some improvement in NIMs (15bps from current levels) and opex ratios (10bps from current levels) over next 12-18 months. We expect RoEs of 16.5% by FY21F and there is more room for potential upside on NIMs/opex. While valuations at 1.9x Sep-20F book are no longer depressed, we see a rerating possibility to 2.5x multiple due to better asset/liability mix than previous cycle and normalisation of ROEs to 16-17%. Maintain Buy and our TP of Rs 750; Axis Bank remains one of our preferred picks.
Nearing the end of the credit cycle
Stress book additions have come off in Q2FY19 and with (i) just 0.4% of SMA-2 loans; (ii) limited CRE exposure excluding lease rentals; (iii) adequate recognition of power stress (60% bookmarked as stressed), we see limited risks of accelerated NPA recognition with new top management.
PPOP surprise likely
PPOP/assets have come off from their 3.2% peak in FY14/15 to 2.4% in FY18. With margin levers and 15bps lower opex to assets, we see core PPOP/assets improving by 30-35bps over the next two years, driving the expected ROE improvement. While lower share of BBB and below loans will dent PPOP to assets, it has been more than made up by higher share of unsecured retail loans and hence NIMs could possibly revert to the previous band of 350-375bps from 335bps.
We expect the new CEO to focus on costs and systems/processes and bring in more accountability. From a business perspective, the corporate bank has seen major exits and plugging that gap would be a priority and an opportunity to refresh the strategy for the division, in our opinion.
Asset quality trend to be stable
Corporate slippages peaking: Stress pools have peaked largely for Axis Bank, with the total stress book including GNPAs declining to Rs 419 bn vs Rs 470 bn in FY17. And more specifically, the corporate stress book has stabilised with no material additions to BB and below book in Q2FY19, and declining slippages in the corporate segment give us comfort that the asset quality cycle is largely behind us. Incrementally over the past 2-3 years, Axis Bank has been lending towards highly rated corporates, which should also lead to a faster normalisation in corporate slippages in our view.
No large risk in corporate book left to be recognised: Axis Bank has lower exposure in real estate; a large part of this is towards lease rental discounting (LRD), and project financing is materially lower. Management indicated that in NBFC/HFC the exposure is not small, but it is not worrying. We also think, in power the stress recognition by Axis Bank is fairly conservative. Hence, we do not expect any material negative surprises in terms of recognition.
Margins should inch up, in our view
We think there are multiple levers in play for corporate banks, including Axis bank, which should aid margins. In the case of Axis Bank, NIMs improvement will come from (i) improving pricing power for banks, (ii) higher yielding asset mix still stable vs last cycle (iii) improving liability profile and (iv) lower international mix.
NIMs drags behind; macro favourable
Axis Bank did enjoy higher NIMs in
FY13-16, due largely to project loans where it enjoyed higher margins. BB and below corporate mix was 19% of loans in FY13. The bank did see material compression in NIMs from 3.9% in FY15 to 3.4% in 1H19 due to deterioration in asset quality cycle. With asset quality stabilising now, the NIM drag due to de-recognition of interest is behind us and given the tightening of liquidity, the current cycle has turned favourable for banks, with pricing power coming back. This will lead to an improvement in NIMs over FY18-21F: we are building in ~15bps improvement in NIMs over FY18-21F, and think there is an upside risk to our margin expectations.