During the recently concluded quarter, the Bank’s NII grew 72.6% y-o-y to Rs3.5 billion. The high NIM (5.9% at the end of Q1’09) ensured the momentum in the NII. This was further aided by a 41% y-o-y increase in advances.
However, moving forward, we believe that such a momentum will be difficult to maintain on account of a likely slowdown in lending and the high interest rates. This is visible in the sequential pattern of the NII, which declined 10%.
Non-interest income fell 15% y-o-y to Rs. 831.2 mn on account of the reduced fee income earned from the distribution of third-party products. However, on a sequential basis, other income improved by 111% as Q4’08 witnessed increased losses on the sale of investments and MTM.
A lack of momentum in the equity markets and a virtual absence of IPOs led to a decline in profitability for the investment banking division. Net profit for the quarter was recorded at Rs96 million, a 50% decline on a yearly basis.
Outlook and valuation
The prevailing economic slowdown and the high interest rate scenario is affecting the short-to-medium-term growth prospects of the company.
We expect investment banking and brokerage to be the most affected businesses on account of a weak momentum in the equity markets. In addition, high interest rates may affect the demand for funds and increase delinquencies, which may adversely affect the bottomline through less interest income and higher provisioning requirements.
We believe maintenance of asset quality and garnering of additional low-cost deposits will play an important role in facing the present macro-environment.
Our FY09 target price of Rs647 for Kotak Mahindra Bank is based on the sum-of-the-parts valuation methodology. The standalone banking business has been valued by using the three-stage Discounted Equity Cash Flow model.
Assuming a sustainable RoE of 16%, we have arrived at a terminal growth rate of 9.9%. Cost of equity has been assumed at 15%. This gives the standalone bank a valuation of Rs119.
Our target price of Rs647 does not offer a significant upside from the current levels, we downgrade our rating on the stock from Buy to HOLD.