Kotak Mahindra Bank rated ‘Overweight’ by Morgan Stanley, says valuations not cheap but are sustainable

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Updated: July 29, 2017 3:20:57 AM

Q1FY18 earnings were 4% above our estimate, mainly driven by securities and insurance business.

Q1FY18, Kotak Mahindra Bank, Morgan Stanley, overweightQ1FY18 earnings were 4% above our estimate, mainly driven by securities and insurance business. (Image: IE)

Q1FY18 earnings were 4% above our estimate, mainly driven by securities and insurance business. At the bank, core PPoP growth was 4% above, helped by higher loan growth and strong fees despite one-time costs. Yet non-core income kept the bottom line below our forecast. Asset quality was strong. OW. Q1FY18: Key positives  Continued pick-up in revenue growth: Loan growth accelerated (18% y-o-y vs. 15% y-o-y last quarter), margins were broadly stable (4.5% vs. 4.6% last quarter), and fees were strong (+43% y-o-y). Thus, core PPoP growth was 30% y-o-y despite one-time costs related to 811 product launch (adjusted cost growth would be 12% vs. 16% y-o-y reported).
Strong asset quality: GNPLs were broadly stable.

The bank guided to exposure of Rs 12.4 bn (0.2% of loans) to four out of  12 accounts referred under the Insolvency and Bankruptcy Code (IBC), primarily inherited from the erstwhile ING Vysya Bank. Credit cost outlook is unchanged—these accounts are well provisioned. Strong traction in capital market businesses (securities, AMC, life): A continued shift towards financial savings helped. On the negative side, profit growth at Kotak Prime was just 10% y-o-y: We cite muted growth in vehicle financing loans. Growth did accelerate in the non-vehicle portion, but this was related to short-term capital market business, so it may not be sustainable.

Earnings trajectory after results — key drivers on track We have liked Kotak given significant scope for strong acceleration in revenue growth, good cost control, improving liability profile, and stable asset quality. We believe the key drivers remain on track. Loan growth at the bank has improved to 18% from 15% last quarter and 12% in F3Q17, mainly helped by the corporate, retail, and CV financing segments. The commercial financing piece is still lagging. In our view, growth here has been affected by GST and issues related to farm loans. The upcoming quarters should show strong acceleration as uncertainty eases.

On margins, while we see pressure for the banking system, Kotak continues to improve its CASA ratio (44% vs. 37% last year). It also has room to cut savings deposit rates, driving stable margins. Fees growth surprised significantly—while we expect strong trends, y-o-y growth should moderate as the base normalises. A combination of these should help accelerate PPoP growth to above 30% in the coming quarters. Coupled with stable asset quality and strong earnings traction at subs, we expect an earnings CAGR of >25% over the next three years. F19e P/E of 24x is not cheap but should be sustainable in the above backdrop.

Valuation  

Banking business: We value Kotak Mahindra Bank banking business using a base case, residual income model—a five-year high growth period, a 10-year maturity period, followed by a declining period. We use a cost of equity of 12.6% assuming a risk-free rate of 6.5%, a market risk premium of 5.5% and a beta of 1.1 respectively.  Subsidiaries: We value Kotak Prime using a base case residual income model; Kotak Life on 3x F19e P/EV multiple; Kotak AMC on a percentage of AUM basis; Kotak Securities by assigning a P/E multiple of 15x to our F19 earnings forecasts; Kotak Investments by assigning a P/B multiple of 2x to our F19 book value forecasts.

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