Kotak Mahindra Bank You aren’t Mr. Perfect, Downgrade to Neutral : Macquarie Research

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Kotak Mahindra Bank
You aren’t Mr. Perfect, Downgrade to
Neutral
Event
 Very expensive at 2.8x FY13E P/BV, little margin of safety, Downgrade to
Neutral: Though Kotak’s fundamentals relative to its peers is expected to be
robust, at 2.8x FY13E P/BV the stock is pricey and there is very little room for
comfort at these valuations. We downgrade the stock to Neutral with TP of
Rs535. The downgrade is purely on account of its expensive valuations.
Fundamentals are expected to remain solid.
Impact
 We are enthused by the financing business: Over the past 12 months the
share of thfinancing business has gone up from 73% on an average to 80%
now. These businesses have been registering excellent growth in profits and
are more stable compared to the capital markets piece, which is very volatile.
Hence the earnings stream going ahead is likely to be strong and steady and
less subjecd to the vagaries of the market. Risk of equity dilution is also the
least, as Kotak is well capitalised. We don’t envisage any capital raising for at
least the next three years.
 Excellent asset quality: Asset quality continues to hold up extremely well,
with NPLs well under control. Gross NPLs including stressed assets have
been declining and gel in line with our thesis that retail-focused banks should
continue to do very well.
 CASA ratio – positive effect of savings rate de-regulation: CASA has
gone up from 26% to 28% QoQ in 3Q12, and KMB have managed to add
close to 0.15mn customers this quarter compared to 0.1mn a quarter before.
So there has been a good 50% increase, which is encouraging. The
management articulated that they are seeing good traction in savings deposits
post the de-regulation.
 Capital market businesses – facing the brunt: Though only 7% of profits
are constituted by non-banking/financing and non-insurance streams, they still
tend to swing earnings a bit. The numbers posted by the investment banking
business and international subsidiaries (predominantly asset management)
were quite dismal this quarter, reflecting the current turmoil in capital markets
Earnings and target price revision
 We are fine tuning earnings and our TP. Changes to EPS have been minimal
and TP is reduced by 3% to Rs535.
Price catalyst
 12-month price target: Rs535.00 based on a Sum of Parts methodology.
 Catalyst: Strong growth and improvement in return ratios
Action and recommendation
 Good stock to own from a long term perspective: Though near-term
upside looks limited due to expensive valuations, we believe Kotak is a good
stock to own from a long-term perspective owing to its sound fundamentals
Valuations and target price
We value Kotak on a sum-of-parts basis where the banking business is valued on a two-stage
Gordon growth model to capture the high growth phase. The life insurance business is valued on an
appraisal value method, whereas other businesses are valued either on a P/E methodology or % of
AUM.
Fig 1 Kotak - Target price calculation
Sum of Parts Per share value Remarks
Standalone bank 354 Two stage Gordon growth model - 3.0x P/BV - FY13E
Life insurance 21 Appraisal value = EV + new business value
Asset management 27 5% of FY13E AUM
International subsidiaries 10 15.0x FY13E net profit
Investment company 5 15.0x FY13E net profit
Securities 29 15.0x FY13E net profit
Investment banking 8 15.0x FY13E net profit
Auto finance 83 3.0x FY13E book value
Alternate assets 7 10% of AUM
Less further investment in subsidiaries (10)
Target Price (Rounded off) 535
Source: Company data, Macquarie Research, March 2012