As expected, Axis Bank delivered weak operating results for Q3’09. While the reported net income did increase 24.3% q-o-q, lower provisioning on standard assets mainly drove it.
During the quarter, the Bank reported a gross NPA ratio of around 1.0%. We believe that a slowing economy would put pressure on asset quality and increase the NPAs over the next 4–5 quarters.
Our base case scenario assumes 2.5% gross NPAs for 2009–10. However, this deterioration will be temporary.
The Bank’s risk-monitoring systems remain robust, and we believe that delinquency rates will fall sharply in 2011 when the economy is expected to be in recovery mode.
In our view, the markets have more than discounted this potential deterioration in asset quality and the concerns are overdone.
While the Bank did show an impressive growth in advances (+9.4% q-o-q, +54.9% y-o-y), we believe the management will have to slow down growth in the loan book, primarily because the economy is slowing down and infusion of fresh capital will be difficult in the near-to-medium term.
Moreover, the high q-o-q growth in Q3’09 was primarily funded by borrowings (incremental credit/deposit ratio of ~230%), which is not sustainable.
We expect advances to grow by around 3% q-o-q in Q4’09, averaging around 30% growth for FY09. For FY10, we expect a fall to around 15%–20% growth, unless the Bank raises fresh capital.
The NIM dropped 39 bps (q-o-q) to 3.12% primarily because of the sharp rise in borrowings and the fall in CASA deposits.
We don’t expect any marked improvements in CASA anytime soon. Moreover, investments in SLR securities as a proportion of deposits is likely to increase, negatively impacting yields. Thus, we expect the NIM to remain in the range of 2.8%–3.0% till FY2010.
We have valued Axis Bank by using the three-stage Discounted Equity Cash Flow model. Our target price of Rs530, assuming a 16.25% cost of equity and a 9.4% terminal growth rate, indicates a potential upside of 21% over the current prices.
Moreover, the stock trades at a P/B multiple of 1.6x, the lowest in the last five years. While the Bank did trade at a P/B of close to 1x during 1998–2003, we believe that its fundamentals have significantly improved since then.
The Bank is now much more stable and has demonstrated its ability to sustain above-average ROEs and growth.
We further believe that the current premium over book is well justified, which gives investors a significant margin of safety. Therefore, we reiterate our BUY rating.