We believe steady loan growth, improvement in leverage (loan/deposit ratio), improvement in loan mix (retail and SME) and steady improvement in operating efficiency should result in gradual improvement in profitability.
Federal Bank reported in line with JEFe. We believe steady loan growth, improvement in leverage (loan/deposit ratio), improvement in loan mix (retail and SME) and steady improvement in operating efficiency should result in gradual improvement in profitability. Retain Buy with a price target of Rs 145. Loan growth — on track. Management had been building up the corporate and institutional banking team over the last two years, and this seems to be slowly paying off. Corporate loans were up 38%. Retail lending excluding gold-loan grew ahead of 20%. The total retail origination in Q2 was Rs 16.88 bn versus Rs 10 bn in Q1. We expect 25% loan growth over next few years. Liability franchise — steady. Aggregate retail deposits are 97% of the total deposit base and has been steadily improving over the quarters. CASA ratio though remains flat sequentially at 33%. NIM to sustain at 3.25%.
Expense — spending on business. Management continues to expect steady increase in operating expenses other than employee overheads toward marketing and promotions. Expense ratio was guided to stay between 49-51% over the next 5-6 quarters. Asset quality — improving. Total stressed assets aggregate to 4.07% of loans, 21 bps lower sequentially. Provision coverage ratio was at 45.3%. Retail and Agri had higher slippages (demonetisation impact). Education loan could worsen owing to Kerala government loan waiver. Management expects credit cost in H2 to be better than H1 FY18. One exposure to Amtek in new NCLT list (84% provisioned).
NBFC subsidiary — FedFina. Net income of Rs 16m in H1FY18 vs Rs 23m in FY17, tracking Rs 1.5 bn of loan origination per month. Capital infusion is likely and management is in talks with 2-3 investors. Tweak estimates. We tweak estimates marginally (by < 1% across FY18-20e). This is driven by higher fee growth (a focus for the mgmt.), slight moderation in NIM offset by higher expense ratio (management willing to incur costs towards growing business). We forecast 28% EPS CAGR over FY17-20E.
Valuation/Risks: FB trades at 2.2x P/B (Sep 17) and 18.7x P/E (12m to Sep 18E) versus 5-year average of 1.5x & 13.4x respectively. We value FB at 2.3x P/B (Sep 18E) and 16.9x P/E (12m to Sep19E).
Risks: Weakness in NRI-CASA and domestic CA flows, inability to rein in costs, asset quality deterioration.