Axis Bank displayed strong operating results in Q2’09, although the asset quality did show some slippage. Net profit increased sharply by 76.9% y-o-y on account of a 55.2% jump in the net interest income (NII) and an 81.4% y-o-y surge in other income.
Net interest margin (NIM) increased 23 bps to 3.51% in Q2’09 as the Bank used its capital to maintain the loan growth momentum.
This was reflected in the 539-bps y-o-y decline in the capital adequacy ratio. However, we expect the Bank to increase investments in low-yield government debt instruments, which may adversely affect the NIM.
Worsening economic conditions are likely to affect Axis Bank’s growth prospects in the short-to-medium term. As the Bank is seeking to raise Tier-II capital in FY09, we believe rising interest costs will affect the NIM.
This will be aided by the Bank likely to invest more in government securities. We expect the NIM to stay flat in FY09 and fall by about 6 bps in FY10. Further, fee income can severely get affected as the Bank may generate less income through loan processing because of the declining growth rate of advances.
Also, the falling equity markets are likely to steer investors away from insurance and mutual funds, thereby affecting third-party distribution income. We expect other income to increase only by 32% y-o-y in FY09, in sharp contrast to the 78% rise witnessed in FY08.
Further, the Bank is anticipating an increase in delinquencies; thus, we expect provisioning to increase by 111% y-o-y in FY09, which may severely affect its bottom line.
We expect the economy to pick up in the next few years. Because the bank boasts of strong fundamentals, we believe that the healthy CASA ratio and asset quality will drive long-term growth on improvement in the macroeconomic scenario, even though the Bank may take a hit in the short-to-medium term.
We have valued Axis Bank by using the three-stage Discounted Equity Cash Flow model and have arrived at a target price of Rs732, having assumed a 16.56% cost of equity and a 12.96% terminal growth rate.
We have reduced our target price after taking into account the deteriorating domestic economic conditions and the likely impact on advances growth and other income. At the current price, the stock shows a potential upside of 18.6%. We reiterate our BUY rating.