Karnataka Bank Ltd BUY - Target Price (Rs.) 190: Greshma

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Karnataka Bank Ltd BUY
Horizon -12 – 15 months
Target Price (Rs.) - 190
Upside -18%

Executive Summary The Karnataka Bank Ltd. provides personal and business banking products and services in India. The company offers current and savings accounts, cash certificates, fixed deposits, cumulative deposits, insurance linked savings bank deposits, and resident foreign currency accounts. It also offers education loans, industrial finance, insurance services and MSME loans. As of March 31, 2010, it had 464 branches, 217 ATM outlets, 8 regional offices and 1 international division.



Key Investment considerations
 Business Momentum picking up
 Cheap Valuations
 Rights Issue of 2 shares for every five held.
 Take Over Candidate.
 Strongest Regional Player in South India
 Fee Income will augment in the coming quarters
 Credit disbursements set to increase
 Strong September Quarter Performance
 Strong Presence in retail segment


Concerns
 MSME and retail sector may lead to higher NPAs.
 Liquidity crunch.
 RBI may raise rates again if the inflation doesn’t cool down.
 Increase in competition from NBFCs


Investment Summary:
 Business Momentum picking up: Karnataka Bank`s (Ktkbank) business growth has picked up in the first half of FY11. We believe this will continue grow in the future driven by an increase in the branches and the initiatives taken by the bank. The business turnover crossed Rs. 40,000 crore in 2010.
 Rights Issue: The Bank is offering a rights issue in the ratio of 2:5 at price not exceeding Rs.100. This will create an additional upside for the stock and higher returns for the investors.
 Take Over Candidate: With the de regulation of the banking sector in the offing, we believe that these small banks will be pt candidates for takeover. This would be a step towards the expected consolidation expected in this sector.
 Cheap Valuations: The company is attractively valued at TTM P/E of 10x and 1.08x P/BV which gives us an ample potential for upside and less risk of a downside.
 Strongest Regional Player in South India: Ktkbank is the strongest regional player in South India with more than 350 branches spread over Maharashtra, Karnataka and Tamil Nadu.
 Fee Income will augment in the coming quarters: KtkBank is planning to increase its branches from the current 464 to 480 branches by end of March 2011. The bank will also be launching new products like Online trading, Travel Card, Gift Card, Smart Card, POS Terminal etc. by the end of current financial year. This will help the bank to diversify its current product portfolio and drive non interest income.
 Credit disbursements set to increase: Credit is expected to grow on the basis of higher CASA ratio which the Ktkbank plans increase by offering different type of savings accounts. Also the bank has simplified its retail loan schemes. The bank plans to focus mainly on Retail as well as MSME sectors for going forward.
 Strong September Quarter Performance: The bank has performed very strongly in the September quarter theincome has increased by 14% and the PAT has increased by 75% to Rs. 287.20 Mn.
 Strong Presence in retail segment: The bank has a strong presence in the retail segment; this will help the bank in augmenting fee income as there is a possibility of cross selling their products of insurance, mutual funds etc. Also in the retail though the volumes are low but they are margins are high and it will improve the banks bottom-line.
Company Background: The Karnataka Bank Ltd. provides personal and business banking products and services in India. The company offers current and savings accounts, cash certificates, fixed deposits, cumulative deposits, insurance linked savings bank deposits, and resident foreign currency accounts. It also provides education loans, home loans, car finance, working capital finance, term loans, and infrastructure finance; business finance products, such as retail trade finance, project finance, export finance, and agriculture finance, as well as finance for small, medium, and large scale industries; debit and credit cards; and insurance services. In addition, the company offers ATM, Internet and mobile banking, money transfer services, and NRI services. As of March 31, 2010, it had approximately 464 branches, 217 ATM outlets, 8 regional offices, 1 international division, 1 data centre, 1 customer care centre, 5 service branches, 2 currency chests, 6 extension counters, and 2 central processing centers. The company was founded in 1924 and is headquartered in Mangalore, India.


Q2 FY 11 Result Update Karnataka bank during the quarter ended Sept 2010 reposted total income of Rs 6.35 billion up by 16% on Y –o- Y basis whereas up by 3.6% on Q –o- Q basis. This was supported by stellar wholesale and retail banking growth. During the quarter the margins of the bank were impacted mainly due to higher provision to comply with RBI guideline of 70% provisional coverage. The net profit after tax was Rs 287 million up by 75% on Y –o-Y basis but down by 38% on Q –o- Q basis. The net profit margin stood at 4.5%.During the quarter the bank posted Net interest income of Rs 1.39 billion which is up by 150% from Rs 554 million in the corresponding quarter last year whereas up by 16% from the previous quarter. The Net interest margin in the quarter stood at 1.87% from 0.85% in Sept 2009 quarter. This has been boosted by increase in CASA from 22.5% in Sept 2009 to 25.6% in this quarter and 25% growth in advances. Key Highlights
 Cost of deposits has fallen from 8.11% to 6.95% on Y –o- Y basis.
 Yield on advances currently stands at 10.7%.
 Main focus on retail banking and targets to take it to 60% of the total business
 Gross NPA stands at 3.66% Vs 3.86% whereas the Net NPA stands at 1.11% down by 23 bps from 1.34% in the corresponding quarter last year.
 The Capital Adequacy ratio in the quarter stood at 12.1%.
 The advances have grown by 20% and currently stand at Rs 156.8 billion.

Valuation Karnataka bank is currently quoting at price by Book value of 1.04x its FY 12E book value of Rs 152. We value banks at discount than its peer due to high Gross NPA and the NIM also stands at 1.87%, we value the bank at P/B of 1.25x at its FY 12E Book value of Rs 152 We arrive at target price of 191 for the stock. We recommend Accumulate for Karnataka Bank with upside potential of 18%from current levels. We also expect stock to rerate once new banking license will be given which we expect decisions to be taken in Q4Fy11 as the stock can be a good takeover candidate.