While RoEs should improve from current levels, they are unlikely to cross 15% over the next two years and 16% beyond that
KMB reported consolidated net profit of Rs 10.56 bn, flat y-o-y on a proforma basis (Kotak + ING) and in line with our estimate. Profits at the standalone bank were up 4% y-o-y. Whilst the bank continued to show stable NIMs of 4.3%, strong average
SA growth of 36% y-o-y and 150bps improvement in cost-to-income ratio, overall balance sheet growth of ~10% y-o-y remains muted along with decline in fee income growth by 23% y-o-y. With Q4FY16 consolidated RoE of ~12.8%, stock trades at ~3.6x FY17e consolidated P/B (average premium of 68% over peers) and prices in strong uptick in RoEs over next 2-3 years. With synergies kicking in, RoEs should improve from current levels but it would be a slow burn; RoEs are unlikely to cross 15% over next two years and 16-17% beyond that.
Retain SELL with unchanged TP of R510 (implied FY17e P/B of 2.6x; FY17e P/E of 21.7x).
Results overview: KMB reported consolidated net profit of R10.56 bn, which was flat y-o-y on a proforma basis. Profits at the standalone bank were up 4% y-o-y and 10% below our estimate. Net interest income was up 13% y-o-y and in line with our estimates. Non-interest income, down 23% y-o-y, was weak and drove the earnings miss. Asset quality remained healthy with stable NPA ratios.
The loan book growth continues to remain muted at 10.4% y-o-y (and ~2.9% q-o-q) on a proforma basis, which the management partly attributed to run down of some erstwhile ING Vysya Bank loans. NIMs were broadly stable at 4.35% on a q-o-q basis. CASA growth at 23% for the combined entity remained strong, with SA growing faster at 36% y-o-y.
CA growth was relatively subdued at 10% y-o-y for the second consecutive quarter. The non-interest income declined by 23% y-o-y on a proforma basis. The management attributed this fall to lower income from mutual fund distribution due to change in regulations. Operating expenses also reduced by ~3% y-o-y for the combined entity despite merger expenses of R70 m during the quarter. Hence, cost-to-income for the combined entity declined to 53% during the quarter vs ~55% a year ago. KMB has incurred cost of ~R1,500 m due to the merger and the management expects additional cost will not exceed Rs 250m.
The asset quality was stable with gross NPA ratio largely unchanged at 2.36%. Restructured book stayed small at 0.26% of loans. The full-year credit cost of 82bps was within management guidance of ~80bps of loans.
Performance of subsidiaries was muted with profits from subsidiaries down 7% y-o-y, driven by weakness in Kotak Prime (net profit down 9% y-o-y), Kotak Securities (net profit down 47% y-o-y) and Kotak Mahindra Capital (net profit down 43% y-o-y). AMC business did better with 41% y-o-y growth in average AUM for FY16 and R250m of PAT in Q4FY16 vs loss in Q4FY15.
The management guided for ~20% loan book growth in FY17, with ~45-50bps credit cost and <50% cost-to-income ratio for FY17. With the integration process about to end in the current quarter, management now believes that the bank is now in a position to leverage opportunities presented by the merger.
Where do we go from here?
KMB’s acquisition of ING puts KMB on a strong footing, giving it entry into southern India and the SME segment, and is a long-term positive for the bank. Moreover, despite tough macro conditions, the bank has been able to maintain its asset quality. This speaks a lot about the management’s conservative approach towards lending. However, it boils down to what the bank can deliver and what valuations it is trading at. In Q4FY16, the bank reported a consolidated annualised RoE of ~12.8% and standalone annualised RoA of 1.5%, with 10% growth on the balance sheet.
The stock is trading at ~3.6x FY17e consolidated P/BV, an average premium of ~70% over private sector peers despite RoEs being on average ~300bps lower than peers. Hence, the stock seems to be pricing in a strong uptick in RoEs and growth over the next 2-3 years. With synergies kicking in, RoEs should also start improving from current levels but it would be a slow burn and RoEs are unlikely to cross 15% anytime soon. We do not expect sustainable RoEs to be more than 16-17%, as: (i) loan growth for the bank is likely to come at the expense of margins due to pressure on yields and higher leverage due to our expectations of muted loan growth at the system level; (ii) it would take time to extract synergies from the merger given the cultural difference between the two banks and hence we expect overall benefits of integration to be less than what the market is expecting. We retain SELL with a TP of R510.