Does IndusInd Bank deserve its valuation boost? Yes, but conditions apply

Hinduja Group-promoted IndusInd Bank’s shares have outperformed the broad market and even most peers by a mile in the past three months. Shares of the private sector lender surged 40 percent in the three months against a 12.4 percent increase in the Nifty Bank index and an 8 percent gain in the broader Nifty 50.

This confidence of investors was triggered by the bank’s robust performance in the first quarter of FY23 and the accompanying positive outlook. Going by the growth metrics in July-September, IndusInd Bank seems to deserve this confidence.

In an early update on the second quarter, IndusInd Bank said its loan book grew at a brisk 18 percent year-on-year and deposits grew at a healthy 15 percent. These compare with the 18 percent loan growth and 13 percent deposit growth in the first quarter.

IndusInd Bank’s loan book has met, and sometimes even exceeded, investor expectations in performance. The lender has been able to reduce sectoral and borrower concentration levels in its corporate loan book.

Its focus on retail loans has improved the outlook on asset quality and growth. The improving outlook for commercial vehicles has only added to the bank’s growth prospects. After all, vehicle finance is the bank's key driver of loans.

Healthy loan growth
True, it had a spot of trouble with the microfinance book inherited through the purchase of Bharat Financial Inclusion. But the book is also showing signs of stability. Analysts expect this growth to support an improvement in return ratios.

“IIB continues to report a strong pickup in loan growth and we expect these trends to remain healthy, which is likely to support margins,” analysts at Motilal Oswal Financial Services wrote in an October 3 note. They expect IndusInd Bank to report an 18 percent loan growth for FY23.

The growth story may be reason enough for the impressive stock gains, but it is not the whole picture. Investors should look at asset quality when the bank details its quarterly performance later this month. In particular focus would be the performance of its restructured book, which compares adversely with its peers.

Analysts from Jefferies India pointed out that the bank has enough buffers to counter stress on its books. “Healthy growth and fall in credit costs should drive earnings turnaround at IIB,” they wrote in their note.
That brings us to IndusInd Bank’s liabilities. While deposit growth has been robust, growth in low-cost current and savings account (CASA) deposits has decelerated in the second quarter.

The CASA ratio was 42.4 percent, down 80 basis points sequentially. A basis point is one-hundredth of a percentage point.

This does not augur well for margins. The share of retail deposits in the deposit book is lower than that of peers. To be fair, IndusInd Bank has cut its reliance on high-cost bulk deposits including certificates of deposits. Also, deposit rates offered by the bank are higher than that of HDFC Bank and ICICI Bank.

What works for IndusInd Bank is that despite the sharp gains, the stock still trades at a modest 1.5 times its estimated book value for FY23. This, along with a favourable growth outlook, is perhaps why brokerages such as Morgan Stanley have an overweight tag on the stock.

Jefferies analysts expect the stock to have a further upside and have a target price of Rs 1,330, which implies at least 10 percent gain from current levels.