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Federal Bank (FED.BO): Undervalued franchise; Initiate with Buy
Source of opportunity
We initiate coverage on Federal Bank (FED) with a Buy rating and
Camelot based 12-month target price of Rs470, based on 1.5X adjusted
book versus average ROA of 1.2% over FY12-14E.
FED is undergoing a restructuring phase under new management which
involves revamping and improving products, business processes and
strengthening risk management. We estimate FED will post earnings
growth of 23% CAGR over FY12-14E on the back of healthy (but not
aggressive) volume growth, stable margins, and better fee income
opportunities. Moderation in slippage on restructuring could provide
further potential for re-rating, in our view.
Catalyst
In its new avatar FED is: (1) focusing on further strengthening its niche
areas such as SME, NRI (Non-resident Indian) and gold-loan-related
businesses over the next three-five years; (2) expanding out of its home
turf into select geographies while offering the same product profile; and
3) improve and revamp business practices/risk management to contain
fresh slippages (about 4% in 2QFY12). We believe three factors will drive
FED’s rerating: (1) lower NPLs and one of the highest coverage ratios at
84% within our Bank coverage universe (Exhibit 117); (2) high capital
adequacy ratio, one of the highest tier I capital ratios, at 15.6%, which
will enable the bank to grow as economy recovers. We estimate healthy
loan growth of 22% CAGR over FY12-14E, driven by corporate loans and
retail gold loans and (3) potential to reduce NPLs given its new strategy.
We expect this to drive 23% earnings growth CAGR over FY12E-FY14E ,
higher than PSU banks at 20% (as it trades at comparable valuations)
and ROA of 1.2%, with the potential to surprise on upside with good
execution.
Valuation
FED is currently trading at 1.1X on 12-month forward BVPS (or 1.2X
BVPS adjusted for 100% net NPLs and 10% restructured assets). We
believe the stock can re-rate to 1.5X (which is our Camelot-derived P/B
multiple), at the high end of its 0.5X-1.5X historical range, given higher
earnings growth and better ROA. We rate the stock Buy with a 12-month
target price of Rs470.
Key risks
1) Successful execution of strategy is key for rerating; any missteps
could hinder this. 2) Strong employee union which has created issues in
the past. 3) Higher slippages, especially in the SME book at 5.5%, remain
a concern given economic slowdown.
INVESTMENT LIST MEMBERSHIP
Asia Pacific Buy list
Coverage View: Neutral
Sector report
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Federal Bank (FED.BO): Undervalued franchise; Initiate with Buy
Source of opportunity
We initiate coverage on Federal Bank (FED) with a Buy rating and
Camelot based 12-month target price of Rs470, based on 1.5X adjusted
book versus average ROA of 1.2% over FY12-14E.
FED is undergoing a restructuring phase under new management which
involves revamping and improving products, business processes and
strengthening risk management. We estimate FED will post earnings
growth of 23% CAGR over FY12-14E on the back of healthy (but not
aggressive) volume growth, stable margins, and better fee income
opportunities. Moderation in slippage on restructuring could provide
further potential for re-rating, in our view.
Catalyst
In its new avatar FED is: (1) focusing on further strengthening its niche
areas such as SME, NRI (Non-resident Indian) and gold-loan-related
businesses over the next three-five years; (2) expanding out of its home
turf into select geographies while offering the same product profile; and
3) improve and revamp business practices/risk management to contain
fresh slippages (about 4% in 2QFY12). We believe three factors will drive
FED’s rerating: (1) lower NPLs and one of the highest coverage ratios at
84% within our Bank coverage universe (Exhibit 117); (2) high capital
adequacy ratio, one of the highest tier I capital ratios, at 15.6%, which
will enable the bank to grow as economy recovers. We estimate healthy
loan growth of 22% CAGR over FY12-14E, driven by corporate loans and
retail gold loans and (3) potential to reduce NPLs given its new strategy.
We expect this to drive 23% earnings growth CAGR over FY12E-FY14E ,
higher than PSU banks at 20% (as it trades at comparable valuations)
and ROA of 1.2%, with the potential to surprise on upside with good
execution.
Valuation
FED is currently trading at 1.1X on 12-month forward BVPS (or 1.2X
BVPS adjusted for 100% net NPLs and 10% restructured assets). We
believe the stock can re-rate to 1.5X (which is our Camelot-derived P/B
multiple), at the high end of its 0.5X-1.5X historical range, given higher
earnings growth and better ROA. We rate the stock Buy with a 12-month
target price of Rs470.
Key risks
1) Successful execution of strategy is key for rerating; any missteps
could hinder this. 2) Strong employee union which has created issues in
the past. 3) Higher slippages, especially in the SME book at 5.5%, remain
a concern given economic slowdown.
INVESTMENT LIST MEMBERSHIP
Asia Pacific Buy list
Coverage View: Neutral
Sector report
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