The corporate book facing stress, however, warrants higher valuation multiples than public sector banks
We split Axis Bank into a bad bank (corporate book) and a good bank (Retail + SME book). Unlike ICICI Bank (ICICIBC IN, Buy) where the bad bank was available at <0.5x Sep-17 book, implied valuations for Axis Bank’s bad book is 0.75-1.0x book. While this provides less downside comfort than was the case for ICICI Bank, we would highlight that: (i) past profitability of Axis Bank’s corporate book has been high versus ICICI corporate book RoEs of just 12-13%; and (ii) stressed exposure of corporate book is 20-25% v/s 30-35% for ICICI Bank. Our good + bad bank valuations imply a fair value range of R475-540 per share for Axis Bank.
* The bad bank (corporate book): Our stress assessment indicates that NPA/restructuring + exposure to stressed groups for Axis Bank is ~20-25% of loans and near-term delinquency/credit costs could be high as stressed metal names have not been recognised. Historically Axis Bank’s RORWA of corporate book at 2.25% has been superior to most banks given better margins and fees on capital deployed (PPOP/RWA of 4% v/s 3.0% for ICICI Bank and 2-3% for PSUs). So unlike ICICI Bank, benchmarking Axis Bank’s corporate book multiple to PSU banks is unwarranted in our view. We think 1.5-1.75x book is a fair multiple for its corporate book.
* The good bank (retail + SME book): Retail + SME book has delivered ~18-20% RoEs over FY12-15 and we expect this trend to continue. Like ICICI Bank we benchmark retail book valuations at 2.25-2.5x Sep-17F book, a discount to retail banks due to its higher mortgage share.
Corporate book not as cheap as PSUs for a reason
Valuing the retail bank at 2.25-2.5x Sep-17F book and corporate at 1.5-1.75x book we get a fair value range of R475-540/share. While our benchmarking of the good bank is the same as for ICICI, the corporate book generates higher RoEs and hence our multiple for it is much higher than for PSUs.
Axis Bank’s corporate book profitability is much better than ICICI/PSU banks
The recent stock correction in corporate bank stocks reflects market concerns over the stress build-up in corporate portfolios and the unrecognised stress in Axis Bank’s infrastructure portfolio. We estimate that ~20-25% of Axis Bank’s corporate book is stressed. While the stressed book remains high, it is lower than ICICI Bank’s. More importantly, we estimate that Axis Bank’s PPOP of corporate book is superior to that of ICICI Bank and the PSU banks.
Splitting the bank into good bank and bad bank–as we did for ICICI Bank
The inch-up expected in impaired book due to higher stress in the corporate book is a clear negative and valuation multiples may remain capped as near-term stress accretion will likely remain high. However, we think cycle RoEs and PPOP/RWA even for the corporate book remained high warranting higher valuation multiples compared to ICICI’s and PSUs.
PPOP/RWA of corporate book highest: While Axis Bank’s RWA/loans in the corporate book was high as for ICICI Bank, it has been able to extract better value with PPOP/RWA of more than 4% over last few years versus ICICI Bank’s <3% and PSUs at ~2-3%. Hence, Axis Bank corporate franchise is more profitable and deserves a higher multiple.
Implied valuations reasonable
Axis Bank’s stock price implies 1x Sep-17F book for the corporate bank (bad bank), valuing the retail bank at 2.25x book (good bank). Given the steady ~18-20% RoEs for the retail book with high concentration in mortgages, we think 2.5-2.75x book multiple for the retail book seems fair. The corporate book has delivered 17-18% RoEs in the past but with higher stress; we expect RoEs of ~10-12% for Axis Bank’s corporate book over FY16-18F before it normalises above 16% again. With no capital dilution need, we see valuations for the combined business as attractive. Our target price implies ~32% potential upside from current levels.
Splitting the bank into good and bad banks
(i) Starting P&L is stressed case: The base Axis Bank model we use to split the bank is a stressed scenario model where NPAs peak at 6% of total loans and the bank experiences ~150bp of credit costs over FY16-18F – while our base case PAT is 5~10% below consensus, it factors in ~65-70% of the stressed loans we have estimated in our “Making sense of the stress” report, while our stressed case factors in all the stress and is 10~20% below consensus.
(ii) Split more base on assets (corporate and non-corporates): While the bank has different segmental P&Ls based on different transfer pricing of deposits, we split the bank by assets. The bad bank is mainly the large/mid corporate book which is ~45% of loans while the other 55% is mainly retail, SME and Agri loans.