While pricing scenario is improving, there is risk to FY20 earnings; stock could see consolidation due to valuation; ‘Neutral’ retained
Kotak’s Q1FY20 standalone and consolidated results were weaker than our expectations on growth moderation in the lending business (loan book largely flat q/q) led by muted growth in cars and corporate/business banking (45% of loans). Having said that, the pricing environment is getting better for Kotak with reduced competitive intensity. Asset quality trends (flat GNPA q-o-q at 2.2%) do reflect prudence in underwriting and the same is reflected in the rich valuations. But, with a moderation in growth vs high growth expectations from the bank, we see risk to our FY20F earnings and high valuations for the bank (3.8x FY21F P/E and 26x FY21F EPS, 20-25% premium over HDFC Bank (HDFCB IN, Buy) could lead to stock price consolidation in the short-term. We prefer corporate banks State Bank (SBIN IN, Buy) and ICICI Bank (ICICIBC IN, Buy) in that order.
Kotak’s standalone core operating performance was weaker than our expectation led by a moderation in loan growth, while NIMs, liabilities and asset quality have held up well. Subsidiary performance was a mixed bag with a weakness in the lending business, while the capital market-linked business has done well.
Operating trends stable
NIMs remained stable q-o-q at 4.5% (up 20bps y-o-y) supporting NII growth of 23% y-o-y (in line with our expectation), but was netted off by weaker fee momentum (up 16% y-o-y) as retail volumes moderated. Opex growth of +20% y-o-y was impacted by higher retirement-related benefits provisioning given a sharp fall in bond yields. Core PPoP grew 18% y-o-y and was weaker than our expectation.
Loan growth moderates but pricing environment getting better
Similar to HDFC Bank, Kotak has also seen a moderation in growth across segments. Loan book including Kotak Prime grew 15% y-o-y with flat book q-o-q (18% y-o-y for the standalone bank) given a sharp moderation in the vehicle segment (down 4% y/y). Business banking has remained weak for two years now and the muted trends still continue and additionally corporate segment is now seeing an economy-linked slowdown as well (corporate banking book grew at 9% y-o-y). While the growth moderation is sharp, management highlighted that the pricing environment on risk-adjusted returns is getting better with reduced competitive intensity which should help the bank gain market share in segments where it is comfortable. Management has indicated that it can still achieve c. 20% growth (standalone) for FY20F, but any continued weakness in the corporate, business banking segment will pose a risk to our growth estimates.
Asset quality reflecting prudence
Gross NPAs were largely stable q/q at 2.2% and this does reflect prudent underwriting with net slippages run-rate at 28bps vs 35bps in FY19. Further, the agri portfolio is behaving well as the bank did not underwrite crop loans in the past few years where the stress is higher for peers. Even in the auto segment, it did run-down dealer financing exposures where it has seen risk levels inching up. Higher provisions were used to improve the provision cover by 150bps q/q.
Liability franchise remains best-in-class
CASA ratio remained stable at 50% levels (adjusted for seasonality) and this remains one of the key strengths for Kotak which has led to the bank closing down the funding cost gap vs. HDFC Bank. The bank has cut the SA rates for <`0.1 mn ticket size to 4% vs 5% earlier which should further add to the margin levers. We had highlighted that Kotak has been gaining large market share and on an absolute basis it is mobilising 50% of CA and the SA quantum vs larger peers adjusted for the government business.