The weak phase should be capitalised to gradually accumulate the stock for the long term.
Kotak Mahindra Bank reported a steady show in the second quarter of FY19. While the headline performance was relatively less inspiring for the bank, the key parameters showed strength and resilience. The bank is gaining market share in business at the expense of PSU (public sector) banks, many of which are under PCA (prompt corrective action of RBI). We expect more gains as the challenges posed by the liquidity led NBFC crisis would lead to significant market share gains for well capitalised banking entities. Kotak Bank is beginning to see pricing power coming back to lenders. On a group level, the conglomerate continues to benefit from strong subsidiary performance.After a strong run in the year, the stock has corrected by close to 17 percent from its 52-week high on concerns pertaining to RBI’s stance on promoters’ stake dilution. While the valuation at 3.4X FY20e banking book doesn’t leave much room multiple rerating, in this weak phase of the stock, investors should gradually accumulate Kotak Bank as a core holding in their portfolios for the stable double digit earnings growth coupled with the significant value unlocking opportunities from its non-banking businesses.
Group profitability – driven asset management, insurance and investment banking
A peek into the quarter suggests that the 21 percent growth in the group’s profitability was contributed not only by the bank but also the subsidiaries of which particularly strong growth was from Kotak Mahindra Capital, Kotak AMC, Kotak Life Insurance and the international subsidiaries.
Kotak Bank delivered a steady performance although the headline profitability was impacted by higher investment provision.
The after-tax-profit growth of 15 percent was supported by 16 percent growth in net interest income (difference between interest income and interest expenditure). While advances grew at a healthy clip of 21 percent, interest margin moderated by 13 basis points YoY (year on year) to 4.2 percent. Non-interest income grew 26.4 percent. The cost to income ratio stood stable at moderated to 46.2 percent.
Total provision rose by 63 percent to Rs 354 crore. Of this, close to Rs 130 crore was on account of investments (both fixed income as well as equities).
Asset quality – still no stress
Asset quality showed no signs of stress with the percentage of gross and net NPA declining sequentially and SMA2 (special mention accounts) of Rs 165 crore still insignificant at 0.09 percent. The provision cover (the total provision on gross NPA) has improved to 63 percent.Growth – good but can get better
Kotak is an extremely well-capitalised entity (capital adequacy ratio of 18 percent) and it is steadily but carefully pushing the growth pedal – while sticking to its risk-adjusted growth strategy.
Compared to Kotak’s absolute share in deposits and advances that stood at 1.7 percent and 2.1 percent in Sep 18, its incremental share in system’s incremental deposits and advances stood at 4.6 percent and 3.2 percent respectively, indicative of smart gains in market share.The bank is seeing signs of pricing power coming back which should have a positive impact on its interest margin, going forward. It is planning to enter new high yielding business like consumer durable financing in the bank.
While advances have grown YoY 21 percent, the bank is growing the book carefully, being mindful of the risks emanating from several pockets. Consequently, the growth in the SME (small and medium enterprises) segment, an area the bank is cautious about, continues to remain muted.
Strong liability franchise
In a hyper competitive retail lending landscape, Kotak Bank is able to compete thanks to the robust liability profile it is steadily building. The ratio of low-cost deposits at the end of the quarter stood at 50.2 percent.
In the quarter gone by, while overall deposits grew 24 percent, savings account and CASA (current and savings accounts) grew by 36 percent and 30.5 percent respectively. The CASA gives it a competitive edge in a retail environment. Thanks to its 811 initiative (digital banking) the bank has doubled its customer base to 16 million at the end of Sep 18. However, in light of the Supreme Court judgement on Aadhaar, the acquisition strategy under 811 is being reviewed.
Source: CompanySupportive subsidiaries
Life Insurance Business reported New Business Premium growth of 28 percent, Kotak Securities had 8.7 percent market share in the cash segment, Kotak Mahindra Capital had a strong quarter and Kotak Mutual Fund’s market share in equity AUM rose to 3.96 percent.
Overall, the Kotak Group’s assets under management rose 18 percent YoY to Rs 1,99,382 crore.
We believe that going forward as these non-banking businesses assume higher share of consolidated profitability (bank contributed 65 percent in Q2FY19) investors may see valuation upside emanating from the consolidated business.In the near term, the sock might remain lacklustre owing to the overhang of promoters’ stake dilution. This weak phase should be capitalised to gradually accumulate the stock for the long term.