Addition to gross NPAs a tad higher; provisioning remains adequate
Deposit growth assumptions re-calibrated downwards; marginal reduction in cost estimates to reflect H1FY11 actuals
TP raised to Rs60; maintain BUY
City Union Bank (CUB) reported a good set of numbers for Q2/H1FY11 with NII clocking in at Rs1.04bn, exhibiting a YoY growth in excess of 75%, primarily driven by a ~600bps expansion in the C-D ratio that reflected in a near-40% loanbook growth as against a sub-30% deposit growth. Net profit clocked in at Rs616mn, driven predominantly by a strong ~70% YoY growth in core fee income, thereby registering a ~35% YoY growth. Although the bank added gross NPAs to the tune of Rs77mn during the Jul-Sep'10 quarter (marginally above the secular run rate), our interaction with the management suggests that the system marking of NPAs is now complete.
What has changed in light of this performance? We have marginally reduced our deposit growth assumptions to reflect the higher C-D ratio that CUB has maintained on an average during H1FY11 and in line with the bank's stated intent of re-calibrating deposit growth to align with deployment opportunities. We have factored in a marginal reduction in cost of deposits (by ~24bps) to reflect the bank’s actual cost of funds as of Sep’10. As a result, our FY11E earnings forecasts have inched up by ~4%.
Valuation and recommendation: At its CMP of Rs50, the stock quotes at 1.8x our FY12E estimates of Rs28.3. Although the stock has been re-rated significantly over the last year or so, we believe there exists further headroom on the upside in light of the bank's H1FY11 performance as well as a promise of what lies ahead. We maintain our BUY recommendation on the stock at current levels with a revised TP of Rs60 - we continue to push CUB as a longer-term multi-bagger driven purely from an organic, fundamental perspective. Our target price of Rs60 implies a 2.1x FY12E P/ABV multiple [a 25% premium relative to 1.7x FY12E P/ABV for South Indian Bank (SIB IN)].
What lies ahead in the next two quarters? We believe that the incremental C-D ratio that has been clocked during H1FY11 is not sustainable and hence, the pace of credit growth will necessarily have to moderate more rapidly relative to deposit growth. We also believe that CUB's cost of deposits has bottomed out at current levels (staying flat at 6.84% during Q1FY11 and Q2FY11). Nearly all of the liability-side re-pricing benefits are factored in the H1FY11 blended cost of deposits although about 6-7% of the term deposits are likely to get re-priced downwards during Q2FY12E. However, given CUB's low-duration working capital asset mix skewed towards SMEs, we expect asset yields to move faster and hence, NIMs to hold steady above 3.4% for FY11E.