We see a profitable journey for this bank and hence recommend buying into the stock as it has potential to rerate from the current valuation.
Axis Bank reported a great quarter, marked by decline in asset quality woes and a decisive commentary on end of asset quality pain. Business growth is picking up and should gather pace as the bank is well capitalised. With a right liability profile, it is at a vantage position to capitalise on the weak competition from state-run banks as well as non-banking financial companies (NBFCs). Margin is improving and the trajectory looks upwards. With core business is fine fettle and significant decline in credit costs, FY20 looks to be a solid year and the glimpses of that should be visible from the second half of FY19. With a new senior management team in place, the road ahead seems exciting. We see value in the stock, which is trading at 2 times FY20e book.Quarter at a glance
The core performance was strong. Net interest income (NII, the difference between interest income and expense) grew 15 percent, driven by 11 percent growth in advances year-on-year (YoY) and 9 basis points reduction in interest margin to 3.36 percent.
Margin, however, improved sequentially (quarter-on-quarter) if one excludes the 17 basis points (100 bps = 1 percentage point) positive impact of interest margin from recovery of an Insolvency & Bankruptcy Code (IBC) List 1 account in Q1 FY19. The management alluded to pricing power returning to lenders in some pockets. This along with steady repricing of marginal cost of lending (MCLR) linked credit book and reduction in interest reversals on account of lower bad assets should support a slightly improved margin trajectory going forward.
Reported non-interest income was soft on account of marked 64 percent drop in treasury income. Core fees grew 9.5 percent, supported by a granular retail and transaction banking fees that now forms 82 percent of total fees. Operating expense growth was well contained.
Consequently, adjusting for treasury income, the core operating profit of the bank rose 16 percent, although the reported pre-provision profit grew 8.4 percent.
With an improvement in asset quality, provision declined, although the bank managed to improve its provision cover (provision on total non-performing assets) to 73 percent, including prudential write-off. The bank intends keeping provision cover around 65 percent in the long term. As slippages decline, credit cost may start to normalise from H2 FY19.
Reported after tax profit of Rs 790 crore was higher by 84 percent from the year ago quarter.Asset quality decisively on the mend
Asset quality, which had been a pain point in the past, showed marked improvement, with gross slippage declining to Rs 2,777 crore.
Of this, close to 39 percent (Rs 1,089 crore) was corporate slippage. It is worth noting that 88 percent of corporate slippage was from erstwhile declared BB and below book. Gross slippage from the non-corporate book was Rs 1,688 crore, suggesting a delinquency rate of close to 0.6 percent.
The management believes that the rating downgrade cycle has now normalised.
Consequently, the total below BB asset pool has shown a sequential decline to Rs 8,860 crore (1.7 percent of gross customer assets). Total stressed asset pool, which also includes restructuring, now stands at Rs 10,948 crore (2.4 percent of net customer assets).
However, the bank has an Rs 825 crore exposure to Infrastructure Leasing & Financial Services (IL&FS, Rs 238 crore funded and Rs 587 crore non-funded) and carries a provision of 20 percent on funded exposure. Should this asset turn delinquent, given the size of the overall book and provision, it wouldn’t meaningfully dent earnings.Decent growth in business
Business growth numbers remain strong. Deposits and credit have both grown in teens and it is interesting to see that Axis Bank has managed to maintain its credit-to-deposit (C/D) ratio despite competitors running a higher ratio, which normally exerts pressure on margin.
While growth in low cost current and savings accounts (CASA) lagged overall deposits growth sequentially, end of the period CASA ratio improved to 48 percent. The bank saw a smart growth in term deposits. The share of CASA and retail term deposits in total deposits stood at 82 percent. The granular stable liability franchise will stand the bank in good stead.Growing but de-risking the lending bookWhile overall advances grew 11 percent, it was pulled down by 12 percent de-growth in the international business, while domestic growth was above system growth at 15 percent. Growth has been led by retail and small and medium enterprises (SME). The corporate book hasn’t grown and stood at 38 percent. The book is much de-risked, with working capital loans growing much faster and corporate exposure at 79 percent and 95 percent of incremental lending rated A or above.
The SME book is dominated by working capital (79 percent) and 89 percent of SME exposure is rated at least SME3.
Improvement in the quality of incremental lending is borne out by slower addition to risk weighted assets. The ratio of risk weighted assets to total assets has fallen 800 bps in the past one year to 72 percent.
After a troubled past, Axis Bank appears to be staring at a much better FY20, which that will see a huge spurt in earnings from normalisation of credit costs. With a strong liability profile, giving it a cost of funds advantage, the bank is ideally placed to capture market share in advances thanks to the void created by state-run banks. The strength of its liability will allow it to grow without compromising on quality or margin. The bank is extremely well capitalised (capital adequacy ratio of 16.17 percent) to take advantage of this opportunity.We see a profitable journey for this bank and hence recommend buying into the stock as it has potential to rerate from the current valuation of 2 times FY20e book.