Kotak Mahindra Bank --Capital market streams backfire::Macquarie Research,

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Kotak Mahindra Bank
Capital market streams backfire
Event
 1Q12 earnings miss because of capital market streams: Kotak’s
consolidated profits came in 10% below our estimate at Rs4.2bn on account
of poor performance in capital market-linked businesses like asset
management, investment banking, securities, etc. The bank and auto
financing businesses continue to do well. We increase our TP by 7% to Rs550
on account of rolling forward to an FY13E-based valuation. Note that the
banking and auto finance business now constitutes nearly 80% of our SOTP.
Impact
 Capital market businesses – facing the brunt: Though only 17% of profits
are constituted by non-banking/financing streams, they still tend to swing
earnings a bit. The numbers posted by securities, investment banking
businesses and international subsidiaries (predominantly asset management)
were quite dismal this quarter, reflecting the current turmoil in capital markets.
The securities business has lost market share by a substantial 100bp in a
single year and has now come down to 2.7% (from a peak of close to 9%).
 We are enthused by the financing business: The banking and auto finance
businesses, which constituted nearly 83% of profits in 1Q FY12, posted 35%
and 20% YoY increases in profits, respectively. The 30bp QoQ decline in
restated NIMs to 5% is mainly due to the changing loan mix, in our view. Kotak
is now trying to increase its share of corporate banking. On a QoQ basis
corporate book has grown 16% compared to 7% for the overall loan book.
 Conference call takeaways: 1) Management was bullish on growth and is
seeing good traction in rural lending, agri and commodity financing, which
seem to be doing well. 2) The loss in international business is due to MTM
hits on FCCB exposures that it has. 3) So far management is not seeing any
major stress in its portfolio, and it is comfortable on asset quality.
Earnings and target price revision
 Increasing earnings for standalone bank: We are increasing our
FY12/FY13E earnings by ~7%. Though consolidated earnings missed our
estimate, the bank’s standalone profits were 7% above our estimate. We are
reducing provisions for the standalone bank, as asset quality is expected to
remain very benign and the bank is moving more toward a corporate portfolio.
 Increasing TP by 7% to Rs550: We are rolling forward to an FY13E-based
valuation. However, the effective increase in TP is less because we are
sharply paring down values for other businesses.
Price catalyst
 12-month price target: Rs550.00 based on a Sum of Parts methodology.
 Catalyst: Strong loan growth, improving RoE.
Action and recommendation
 Reiterate Outperform with TP of Rs550: We believe the bank’s smaller
dependence on volatile income streams is likely to result in more consistent
earnings growth and return ratios.