Buy Karnataka Bank 3QFY11 – Lower estimate, price target; Anand Rathi

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Karnataka Bank
3QFY11 – Lower estimate, price target; re-iterate Buy
We lower our FY11e/FY12e EPS 7%/6.7% for Karnataka Bank
due to higher NPA provisioning. We value the stock at 1.4x
FY12e ABV (earlier 1.45x) owing to lower RoE, and reduce our
target price to `206 from `223. We retain our Buy
recommendation as we expect the bank’s improving margin,
higher fee income potential and better productivity to drive RoE
expansion to 15.3% in FY13e from 9.9% in FY10.

 Modest business growth; improving NIM. Net interest income
grew an impressive 56.5% yoy despite modest growth in business,
with yoy growth of 19.7% in credit and 16.2% in deposits. CASA
share improvement of 295bps yoy to 24.9% and a higher creditdeposit
ratio of 64% led to NIM improving 22bps qoq to 2.2%.
 Higher productivity and fee income. Core cost-to-income
improved 1,043bps yoy to51.7%, despite additional provision of
`125m for gratuities and pension. Fee income grew 15.8% yoy
and is a key management focus area.
 Asset quality deteriorates, but NPA coverage adequate.
Gross NPAs rose 8.6% qoq, with slippages mainly from its agri
portfolio. Management does not expect further delinquencies
from this and believes there will be strong recovery ahead. Also,
NPA coverage is sufficient at 70%.
 Valuation and risks. At our target price of `206, the stock would
trade at 1.4x FY12e and 1.2x FY13e ABV. Key risks: Higher credit
costs due to lower-than-expected NPA recoveries.