Stock pricing in strong recovery in business and success in new initiatives
Raising the bar as the new cycle begins. Post our recent interaction with the management, we expect IndusInd Bank to emerge different, but far stronger than before as the third phase of development has begun this year. Even as the bank would continue to increase its presence across India, the loan mix and revenue drivers are likely to be diversified with a greater emphasis on new mediums to acquire/retain clients. An attractive idea, but valuations are rich. Maintain Add with a revised TP (target price) at R800 (from R680 earlier).
Planning cycle 3.0–building on 3D: dominate, diversify and differentiate: Our recent interaction with IndusInd Bank revolved around the strategy adopted by the bank for the next cycle of growth. It essentially rests on three pillars: dominate, diversify and differentiate. We like the bank’s strategy that is aimed at (i) increasing points of contact with the customer, but look at geographies where the bank can dominate, (ii) identifying new ways to engage with the customer, and (iii) building new revenue streams by expanding into new loan segments and fee pools. Given the strong track record on execution under the two different planning cycles, we see the probability of success as reasonably high. As we exit the current cycle, we believe that the loans would see lower dominance of commercial vehicles on assets, greater share of low-cost liability and strong performance on fee income to represent the bank.
Revenue growth drivers broadly intact; softening of cost of funds should aid improvement: With limited concern on impairment-related issues, we draw comfort from the fact that the management has been largely focusing on building scale at this stage. The bank is expanding its distribution network strongly, a trend that is likely to continue over the next few years. The bank is adequately compensated for this phase of expenditure as the revenue growth is likely to remain strong at 20% CAGR (compound annual growth rate) on the back of strong growth in NII (net interest income) (20-22% CAGR) and non-interest income (18-20% CAGR). Any decline in wholesale cost of funds and ability of the bank to continuously improve CASA (current account savings account) ratio should aid faster revenue growth. The bank is well-capitalised with tier-1 ratio at 12% and healthy RoEs (return on equity) of 18-19%.
Valuations are rich; our positive view reflects the potential earnings growth: At 3.4x book and 20x FY2016e EPS (earnings per share), IndusInd Bank is probably closer to our fair value. Valuations, in our view, are at the upper end, giving little headroom for expansion from current levels.
The stock is pricing in strong recovery in business and assigning a high probability of success to most of the recent initiatives taken by the bank. However, our positive rating essentially is driven by the superior execution, strong return ratios and scalability of the business given the size of the bank and opportunity in the market. We have marginally increased our earnings estimates, but have increased our TP to R800 (from R680 earlier) to reflect roll-forward of earnings, which gives an upside of about 5% from the current levels.
By Kotak Institutional Equities