J.P. Morgan - Kotak Mahindra Bank

Kotak Mahindra Bank (KMB IN) 4Q14: margins improve; growth slowdown on expected lines		Neutral Price: Rs807.00 29 Apr 2014 Price Target: Rs700.00 PT End Date: 31 Mar 2015

Kotak Bank reported PAT of Rs6.6bn (down 2% y/y). The parent bank delivered in-line PAT of Rs4.07bn (down 7% y/y). Loan growth remained muted, on expected lines given the weak macro; however, Management is optimistic on loan growth from hereon and expects to grow in the high teens in FY15E. Asset quality improved during the quarter; management is positive on that front as well in the future. The stock is a good long-term core holding; however, we maintain our Neutral rating mainly on account of valuations at 3x P/BV and 22x P/E (FY15E).

Table 1: 4Q14 result table

	4Q13	3Q14	4Q14	YoY	QoQ
Net interest income	13,205	13,992	14,841	12.4%	6.1%
Non interest income	14,418	14,303	17,499	21.4%	22.3%
Non interest expenses	17,733	18,785	22,547	27.1%	20.0%
Pre Prov profits	9,890	9,510	9,793	-1.0%	3.0%
Provisions	436	639	-6	-101.4%	-100.9%
PBT	9,454	8,871	9,799	3.6%	10.5%
Tax	2,714	2,873	3,036	11.9%	5.7%
PAT	6,740	5,998	6,763	0.3%	12.8%
Affiliates/Minorities	84	228	207	Nn	Nn
Attributable PAT	6,656	5,770	6,556	-1.5%	13.6%
Cost/Income	64.2%	66.4%	69.7%	5.52%	3.33%
Prov/PBT	4.4%	6.7%	-0.1%	-4.47%	-6.77%
Tax rate	28.7%	32.4%	31.0%	2.28%	-1.41%
NIM	4.7%	4.9%	5.0%	0.27%	0.07%

Source: J.P. Morgan estimates, Company data. Standalone P/Loss result table and subsidiaries break up at the end of the note.

· Loan growth. Loan growth remained muted at 8% y/y; mainly because of a conscious decision to contract the CV/CE book (down 30% y/y and 9% q/q). Loan growth excluding the CV/CE and auto segment was at 16% y/y. Management expects strong loan growth of high teens in FY15E mainly from the consumer banking business and the Agri segment, which has been the focus area for the bank. CV/CE segment book is also likely to grow in the near term.

· Asset quality. Asset quality improved during the quarter, with improvement in Gross & Net NPL both in absolute and % terms. Management is positive on the asset quality front and expects it to further improve in the medium term. Management is now more sanguine on the CV/CE segment and does not expect any negative surprise in the near term.

· Margins. Margins improved by ~10bp and stood at 5% in 4Q14; mainly because of lower funding cost, which was down ~11bp. Management expects margins to remain stable in the medium term; with further improvement in funding costs. SA balance growth was strong at 11% q/q, whereas CA balances grew 22% q/q. This led to overall improvement in CASA which stood at 31.9% (up 213bp q/q). Retail term deposit growth was also strong at 35% y/y.

· Subsidiaries. Kotak Prime reported muted loan growth (up 2% y/y) given the weak macro. However, asset quality improved q/q with Net NPLs of 0.3%.The operating environment improved for the capital market related business with the broking business witnessing higher volume growth during the quarter. Management is aggressive on buying stressed asset portfolios, given the higher opportunities in the market. It expects the ARC and the alternate asset business to witness higher activity in FY15E.

Figure 1: Lower funding costs led to improvement in margins

Source: Company data.

Figure 2: Savings balance witnessed robust growth

Source: Company data.

Figure 3: Loan growth was muted; however expected to improve in FY15E

Source: Company data.

Table 2: 3Q14 standalone results

	4Q13	3Q14	4Q14	YoY	QoQ
NII	9,034	9,127	9,665	7.0%	5.9%
Other income	3,639	2,997	3,405	-6.4%	13.6%
Total Revenues	12,672	12,125	13,070	3.1%	7.8%
Employee expense	2,883	2,773	3,157	9.5%	13.8%
Other expense	3,256	3,504	3,843	18.0%	9.7%
Operating expense	6,139	6,277	6,999	14.0%	11.5%
PPOP	6,534	5,847	6,071	-7.1%	3.8%
Provisions	374	697	-62	-116.5%	-108.9%
PBT	6,160	5,150	6,133	-0.4%	19.1%
Tax	1,798	1,750	2,061	14.7%	17.8%
PAT	4,362	3,400	4,072	-6.7%	19.8%
Standalone Loan book	484,690	531,490	530,280	9.4%	-0.2%
Standalone margins	4.69%	4.87%	4.98%	0.29%	0.11%
NIM	4.70%	4.90%	4.97%	0.27%	0.07%
CASA	29.2%	29.7%	31.9%	2.64%	2.13%

Source: J.P. Morgan estimates, Company data.

Table 3: Consolidated loan book break up

	4Q13	3Q14	4Q14	YoY	QoQ
CV loans	78,050	60,050	54,410	-30.3%	-9.4%
Car loans	127,500	130,220	132,230	3.7%	1.5%
Personal loans	30,540	31,890	34,390	12.6%	7.8%
Home loans	103,290	114,540	120,990	17.1%	5.6%
Corp/SME	197,520	246,720	227,070	15.0%	-8.0%
Others	125,680	126,990	147,840	17.6%	16.4%
Total Loan book	662,580	710,410	716,930	8.2%	0.9%

Source: Company data.

Table 4: Subsidiaries break up

	4Q13	3Q14	4Q14	YoY	QoQ
Kotak Mahindra Bank
PAT	4,360	3,400	4,070	-6.7%	19.7%
Kotak Mahindra Prime (KMP)
Profit before royalty & taxes	1,581	1,900	1,920	21.4%	1.1%
PAT	1,051	1,230	1,260	19.9%	2.4%
KMCC
PAT	40	70	50	25.0%	-28.6%
Kotak Securities
Total income	1,461	1,680	1,600	9.5%	-4.8%
PAT	381	460	440	15.5%	-4.3%
Kotak Asset Management
Total income	20	470	420	-	-10.6%
PAT (AMC and Trustee Co.)	20	120	40	100.0%	-66.7%
Kotak Insurance
Gross premium income	5,951	5,990	10,060	69.0%	67.9%
Profit	531	600	650	22.4%	8.3%
International subsidiaries
PAT	-10	90	60	-700.0%	-33.3%

Source: Company data.

 

Investment Thesis

1. Kotak Bank is a good long-term core holding, in our view. Management quality is high, distribution is growing strongly (the recent RBI liberalization helps), and it is steadily diversifying its product portfolio.

2. We expect the asset quality for the bank to be much better than that of its peers given that: 1) the bank has de-risked its book in stress sectors like CV/CE much ahead of its peers; and 2) it has no exposure to stressed sectors such as infra/power.

3. The bank is focused on improving the liability franchise instead of focusing on growth, which we believe is the right strategy and will pay high dividends in the longer term.

4. Kotak is the most expensive bank in India today. It trades at a significant premium to HDFCB on P/E – this isn’t visible on P/BV, but Kotak’s ROE is much lower because of its high capital ratios.

Valuation

Our Mar-15 PT for Kotak of Rs700 is based on a 2-stage Gordon growth model implying 2.5x Mar15E book. Our valuation factors in a cost of equity of ~16%, normalized ROE of ~24%, and terminal growth of 5%.

Risks to Rating and Price Target

Key downside risks to our Neutral recommendation are: 1) a slowdown in retail credit due to weak sentiment which could have an impact on the growth prospects for the bank and therefore profitability; and 2) asset quality shocks from specific events in segments such as CV/CE and SME space, thereby increasing credit costs for the bank. A key upside risk is higher-than-expected growth due to improvement in macro environment resulting in strong revenue growth.

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