Federal Bank rating ‘buy’: Lower provisions, tax drove robust earnings

By: |
January 25, 2020 8:08 AM

Unlike for peers, asset quality has held up well; gradual recovery in RoEs is expected; ‘Buy’ maintained

Federal Bank rating, Asset quality, RoEs, Retail loan growth, NBFC, mid-cap banks, SME segmentFB has reported a fairly stable performance on asset quality in an environment where we have seen several banks reporting disappointing performances

Federal Bank reported solid earnings growth of ~32% y-o-y led by sharp decline of 15% y-o-y in provisions and ~23% y-o-y in tax rate. Loan growth slowed to 13% y-o-y while NIM was flat q-o-q, resulting in 5% growth in operating profits. Asset quality has held up well resulting in 2% slippages with limited concern on small-ticket loans. Federal Bank has executed well and we see a gradual recovery in RoEs leading to our positive view. Maintain Buy (fair value at Rs 120, unchanged), our top mid-cap idea.

Operationally weak; lower provisions and tax rate driving earnings growth

Federal Bank reported 32% y-o-y growth in earnings mainly driven by lower provisions (-15% y-o-y) and lower tax rate (-23% y-o-y). Operating profits grew 5% y-o-y led by 10% y-o-y growth in revenues while operating expenses grew 15% y-o-y. NII growth was weak at 7% y-o-y led by modest 13% y-o-y loan growth primarily on account of weak corporate growth (6% y-o-y). Retail loan growth was strong at 22% y-o-y while the SME segment grew 12% y-o-y. Non-interest income growth was strong at 18% y-o-y. Credit cost was low at 60 bps.

Asset quality holds up well

FB has reported a fairly stable performance on asset quality in an environment where we have seen several banks reporting disappointing performances. The bank reported unchanged gross NPLs of 3% and net NPL of 1.6% q-o-q. Provision coverage ratio declined marginally (calculated basis). Slippages at 2% are better-than-peers with the underlying trends across segments showing no negative surprises. The bulk of the slippage has come from the corporate segment and primarily, from two NBFCs. The management indicated that there is no near-term stress emerging in the large corporate book while the stress in other segments is within expected limits of each product segment.

Retain Buy rating

We value the bank at ~1.7X book and 13X December 2021e EPS for RoEs in the range of ~14% in the medium term and strong earnings growth at ~25% CAGR over FY2019-22e. In an environment where we have seen several mid-cap banks showing deteriorating asset quality trends, we note that Federal Bank has emerged stronger. The disappointment, if any, stems from the progress of return ratios, which has been slow. The management is guiding for 1.1% RoA for FY2020 and 1.2-1.25% RoA for FY2021, a bit higher than our current estimates. Achieving this would result in RoEs moving to 15% levels but unlike other banks, the levers are a lot more challenging as it has to be driven by better NIM, fees as well as cost ratio improvement. The improvement is slow and we would be a bit more conservative at this point in building these into our estimates.

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