Why has Kotak Mahindra Bank stock’s valuation de-rated?

During the last week of February, Kotak Mahindra Bank has raised the rate by 15 basis points (bps) to 7.4% for retail deposits in the highest rate slab of 390 days to less than 23 months. This is the second hike in less than a quarter after having taken the same quantum of hike in December.  (Mint)
During the last week of February, Kotak Mahindra Bank has raised the rate by 15 basis points (bps) to 7.4% for retail deposits in the highest rate slab of 390 days to less than 23 months. This is the second hike in less than a quarter after having taken the same quantum of hike in December. (Mint)

Summary

Rising competitive intensity across business verticals has led to continuous de-rating in Kotak’s valuation over the last two years.

Kotak Mahindra Bank is the latest private sector bank to vindicate the Reserve Bank of India (RBI) governor’s view at the last policy meeting in February that transmission of tightened monetary policy is yet to take place fully. 

It is clear that most banks underestimated the RBI’s resolve to fight inflation with tight monetary policy so far as they had refrained from hiking deposit rates aggressively to maintain profitability. Now, Kotak has joined the bandwagon of banks raising their deposit rates.

During the last week of February, the bank has raised the rate by 15 basis points (bps) to 7.4% for retail deposits in the highest rate slab of 390 days to less than 23 months. One basis point is 0.01%. Notably, this is the second hike in less than a quarter after having taken the same quantum of hike in December. 

Kotak FY23 annual report shows that deposits maturing in 1 year to 3 years category are 1.85 trillion, accounting for almost 50% of the total deposits of 3.63 trillion. The only caveat here is that there could be some overlapping in terms of the interest rates published for a category and maturity pattern classification in the annual report.

While it is difficult to ascertain the precise impact on net interest income as there will be a rate hike on advances too, this does lend credence to the Goldman Sachs report on the banking sector stating that the strong profitability for the financial sector is over.

Furthermore, Kotak’s traditional business verticals are also witnessing a slowdown in growth rates. For example, despite growth in overall average assets under management (AAUM) at 23% and equity AAUM at 32%, Kotak AMC has reported a fall in profit after tax from 150 crore in Q3FY23 to 146 crore in Q3FY24. 

Kotak Securities, the company’s stock broking business, has seen a drop in cash segment volume, leading to a decline in brokerage income to 1,447 crore in FY23 from 1,674 crore in the previous year. Though it has reported a 25% growth net profit in Q3FY24, the pressure on profitability is evident. 

When stock market volumes are growing and the company’s market share has risen more than 50% from ~6% to ~10%, the bottomline growth of 25% is not impressive. This could be partially owing to the new age brokers like Zerodha and others putting a lot of pressure on the yields /rates of retail stock broking. 

To respond to the competition, Kotak Securities has also come up with zero brokerage plans for clients under 30 years of age and brokerage waiver for intraday trading for all clients. This would essentially mean that they are hoping that the gains from interest on margin trading facility would compensate for the zero/low brokerage.

Coming to the relatively new businesses of non-life and life insurance, the picture isn’t rosy either. Recently, Kotak Mahindra Bank decided to give up its majority stake in general insurance business. 

Zurich Insurance would have a 70% stake in the general insurance business that has struggled to make a mark with a market share of less than 1%. The bank’s life insurance business has also failed to pick up materially as is evident from its market share of less than 5% in new premium in FY23 and likely to stay around the same in FY24.

Unsurprisingly, rising competitive intensity across business verticals has led to continuous de-rating in Kotak’s valuation over the last two years.

The stock peaked out in October 2021 at 2,253 apiece and is currently trading around 25% lower than that level. The de-rating in valuation is evident whether one looks at the price to adjusted book value (P/ABV) multiple or even price-to-earnings (P/E) multiple. 

Though the bank’s consolidated adjusted book value has been on an upward trajectory from 426 in FY21 to 651 in FY24E, its P/ABV multiple has come down consistently from 4.0x to 2.6x. Consolidated earnings per share too has been going up from 50 in FY21 to 90 in FY24E, but P/E has dropped from 34x to 19x.

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