Federal Bank:: Raise PO to capture rising positives; Buy : BofA ML

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Federal Bank:: Raise PO to capture rising positives; Buy

􀂄 Raise earnings and PO to capture rising positives
We raise PO on Fed Bk to Rs575 to capture the increase in our EPS estimates
(+1%/4% for FY11/12 respectively) post their strong 2Q operational results. We
estimate earnings growth of +34/40% in FY11/12 driven by margins sustaining at
+3.8-3.9% and credit costs falling to <100bps by FY12 (vs. ~160bps in FY11E).
After our recent upgrade (see- Federal Bank, 18 October 2010), we are growing
confident of Fed Bk’s ability to deliver on return ratios (RoA’s to ~1.5% vs 1.1% in
FY10 and RoEs to +15.5% by FY12 vs. ~10% in FY10). Hence, we believe the
stock can trade up to +1.7-1.8x FY12 book. Preferred mid-cap pick.



2Q11: reported earnings miss est.; but core +10% ahead
While Fed Bk reported earnings of Rs1.4bn, 39% yoy growth, they were +5-6%
below est. on higher provisions (pension costs and investments). But operating
level earnings were strong (10% ahead) driven by topline (margins). Fed Bk’s loan
growth down to 7% yoy as bank is in consolidation phase. Topline (3% ahead)
grew 33% yoy on expanding margins (up 74bps yoy to 4.4%). Fee growth muted
(5% yoy growth), but other income was +30% ahead on higher cash recoveries.

NPL rise stemmed; Mgmt. confident of further improvement
Headline gross NPLs rose by 5% qoq, but net down 7%; coverage at +82%
(+92% incl. w/o’s). What is comforting is that net NPL formation (net of recoveries
and upgradation) also declined qoq to Rs1.3bn (vs. Rs2.3bn in 1Q); +75% from
SME and retail. Further, mgmt. also guiding for qoq decline ahead vs. earlier high
formation level sustaining. We are estimating net formation to decline in 2HFY11
(factoring in higher recoveries / upgrades in 2H) to +Rs2.8bn vs. Rs3.6bn in 1H.