Brokerage house Kotak has downgraded private sector lender DCB Bank to sell from buy and lowered its target price.
A day after it posted a tepid September quarter numbers, brokerage house Kotak downgraded private sector lender DCB Bank to sell from buy and slashed its target price to Rs 100 from Rs 150 earlier. Anand rathi has also has a sell rating on the stock with a target price of Rs 95. The downgrades coupled with weak Q2 were enough to spook the street that led the stock to fall 20 percent on Wednesday.
Although the bank posted a decline in its Q2 net profits, that's not why brokerages are downgrading the stock. They see a significant impact on the P&L accounts due to a strategy change introduced by the bank. The strategy changes are:
-To double the number of branches to 300 from 150
-To increase headcount to 5400-5800 from 3700 in next 12-15 months
-To invest heavily in customer facing, frontline enabling technologies
As a result of branch expansion, DCB's P&L account is estimated to see an impact of Rs 9-15 cr in FY16, Rs 50-65 cr in FY17 and Rs 20-35 cr in FY18 and will further impact the cost to income ratio of the bank which is already amongst the highest in the industry. Analysts now fear that the expansion will increase cost-to-income ratio in the near term while ROE will decline. Both Kotak and Anand Rathi see cost-to-income going up as much as 65 percent.
DCB management, however, expects this accelerated investment programme to break even in 24-30 months. Defending the move, DCB chairman Nasser Munjee says the bank is not changing its business model and the investment has to be made in the face of intensifying competition. "Business development can take place only through branch expansion," Munjee told CNBC-TV18 in an exclusive interview.
Not only is Kotak not convinced by the new strategy, but also fears the move could lead to repeating mistakes that the bank committed in the past decade. In its report, Kotak says: "DCB is looking to double branches to 300 & employees by 50-60 percent in next 12-14 months in what appears to be a very dangerous, unexpected and disappointing shift in their strategy of steady improvement in cost ratios, focusing on risk and improving return ratios."
Justifying its call to downgrade the stock, Anand Rathi says: "We believe the ROA and ROE of DCB will range of 50-60bps and 6-9 percent, respectively. Cost to income ratio could rise to 65-70 percent for the next 3 years leading to a significant downward revision in our estimates."
Below is the verbatim transcript of Nasser Munjee’s interview with Reema Tendulkar, Latha Venkatesh and Ekta Batra on CNBC-TV18.
Reema: Could you walk us through the strategy for increasing your branch expansion and upping your employee base by 50-60 percent. What prompted it?
A: DCB has been showing steady growth quarter by quarter and we hope to repeat that as we go forward. But with the competition intensifying, we need to expand our presence throughout the country and we took a call that we need to accelerate the pace of network expansion while keeping the business model exactly the same. We are not changing the business model at all.
Latha: That is exactly the point. It is the increase in branch count and headcount that you are using as the instrument to meet more banks that will be in the fray. That will willy-nilly bring down your return on assets (RoA) and bring down your margins. What are your own expectations in terms of impact on margins, impact of cost to income over the next 24 months?
A: This is a call we have to take for the future development. I mean one option is that we do nothing. We stay and we grow at 25-30 branches a year and keep that growth. I do not see that as a viable strategy. What we need to do is up the ante a little bit. It will affect positive income ration as we move forward. Obviously we will impose cost on ourselves. But the business development can only come through branch networks. It is not coming through corporate lending. We are a retail bank and it has got to grow. That presence is an investment that we are making. There will be an impact over the next year. This year we are okay but, next year, there will be impact. But that is an investment that we have taken a call to make.
Ekta: You have guided in your press release that your return on equity (RoE) as well as your return on assets are going to decline over this certain period. If it stands currently at 8.92 and 0.89 percent respectively, how much lower do you think it can go and where will it sustain up till FY22?
A: It depends obviously, if we are going for this expansion and our capital call may be towards the end of the next year, it is going to affect RoE, but this is an investment that we have to make for our future. I do not think we have an alternative.
Ekta: By how much?
A: It is hard to tell at the moment.
Latha: I would assume that you are responding to the competition that will come not just from the two new banks, I mean Bandhan Bank and IDFC Bank really will not be a challenge as much as payment banks which are being parented by people with very deep pockets and huge telecom networks. Exactly what is the challenge? You expect they will take away your current and savings account (CASA) ratio?
A: Obviously, CASA is a very critical element, deposit is a very critical element of an impact, plus it is a good opportunity for us to come to a different level in terms of geographical outreach. We have experience, we know where things work, we know exactly how to set up branches, on what basis to set up branches and how we can estimate our breakeven as well as product. All our branches are full product branches. It is not that we are just looking at one or two things. It is a full product branch. So, that model will be unfolded as the year goes by. Now if we find there is some problem, we can always pair back if we need to. There is flexibility. There is nothing sacrosanct about 150 branches. But the intention is that we need to roughly double the network over the next 12-15 months. It depends on how well we can do it.
Latha: Even if you double from 150 to 300, that still will not quite answer the kind of competition you are getting from the telecom networks.
A: Yes, but the point is what is the option.
Latha: Would you want to liaise? Would you want to ally with any?
A: We do not. At the moment, there are some who talked to us; there is certainly a possibility of alignment which we are exploring. But that does not take away from the fact that we need a, we can have a lot of synergy that comes in as well. So, there are lots of possibilities and opportunities and we are not keeping anything, any option closed.
Ekta: Would you need to raise funds in the near future to fund this expansion strategy?
A: We do not see that until in the next year.
Ekta: And how much is the entire expansion going to cost up till FY18?
A: I cannot give you a number at the moment.
Latha: Do you expect that the new payment banks and even the new banks, IDFC and Bandhan and the small banks offer more by way of savings rate? That is what Kotak Mahindra Bank and Yes Bank did and still do. Do you expect the new guys also to offer more in terms of savings rate, in which case you may also have to raise?
A: No, we will not raise. Kotak raised, these others may raise, they offer interest on current accounts, we will not. We have faced the competition, we have grown substantially on our CASA base without increasing rates and that is what the branch network allows us to do.
Latha: So, the branch network is to get more retail money and lend more retail loans?
A: Absolutely. That is our business model.
Latha: But if you can wear your hat as a financial expert rather than just the DCB Chairman, do you think there is, there has to be a lot of consolidation in the midcap banking space? I mean State Bank of India (SBI) would have survived anyway. They have actually allied with Reliance Jio. ICICI Bank, perhaps would have survived anyway, they still have FINO. And Bharti Airtel has some kind of an alliance with Kotak. The point is a lot of the big boys are trying to find their own allies. Do you think the midcap space, whether public sector or private sector has to see consolidation?
A: I have never bought that idea, quite honestly. The United States has 3,000 Unity Banks all over and there is a community bank structure and community banks know their communities better than any of the big boys do.
Latha: But you are not a community bank, you are all over the country, in many parts of the country.
A: The point is our philosophies work in certain clusters and we work in those clusters, we understand those clusters and we create those clusters and there is enough opportunity for smaller banks to be very vibrant and very innovative in the way we do it. Technology helps enormously. So, in a sense of a combination of physical presence and technology, technology can leverage physical presence in a very big way. So, I do not buy that argument.
Ekta: I do not mean to put you on the spot, but we have seen two downgrades come in from the analyst community this morning. Do you think that it might just be in the investors’ best interest to maybe scale back the expansion plan or delay it till you have more certainty or the analyst queries are addressed with more certainty?
A: Some analysts are taking a very positive view. Some have taken a negative view. This will be a normal reaction. Some people wanted us to grow much more aggressively earlier, which I refused to do. So, now when I say I am going to do aggressively, they are saying it is too much. So, there is no winning on this. We have taken a decision on the best available information, we have of our capabilities and our capacity, our business model and to see how much we can expand that space as quickly as possible. That is a call we have taken. We are not retracting on it.
Latha: Are you saying that if you did not have the branches growth that you have now proposed, you will not be able to maintain this kind of loan growth and this kind of margins?
A: No, you will not because where do we grow our CASA, where do we grow our deposits, how would we grow our balance sheet, it's not on corporate lending.
Reema: So, then to take the growth point forward, your net interest income by the end of FY15 was about Rs 500 crore, with the branch expansion in place in the next 12-18 months, what would be the targeted topline that the company is anticipating?
A: In what period?
Reema: Once you are done with your branch expansion, we just wanted to understand that in your study, what do you model?
A: Roughly we are looking at the balance sheet size of doubling the bank in five or six years. So that is roughly the ballpark we are in. It is not that we are speeding it up; we are not doing anything too quickly. It is going to take five or six years to do this.
Latha: You spoke in passing about alliances. What kind of alliances were you looking at?
A: At the moment, there are lots of opportunities; there are players who are looking for banks as partners, that sort of thing. We are not looking, as I mentioned, it is an open space. We are looking and talking and looking at possibilities and potential. We will leverage our strength as best as we can over the next two years.
Ekta: What is your outlook with regards to gross non-performing loans (NPL) because we do understand there were some small and medium enterprise (SME) accounts this quarter which were a bit of a niggling worry?
A: The economy as I see it has major problems. The industrial economy and the manufacturing economy are seeing no traction at all. Now, as a result of which we are going to see, we are seeing a cash problem right across the SME sector. So, there is a cash flow problem, there is not a business problem. So, I think we will have to weather this storm. But given the nature of our portfolio, I want to keep my net NPLs hovering around one percent, no more.
Reema: Can you quantify the capital call at least that will be required next year?
A: I do not want to anticipate that at the moment. We know roughly what it has been, but I do not want to anticipate.
Ekta: Your loan book mix will remain the same going forward. Mortgages will be 40 percent or will you increase your corporate exposure at all?
A: Our business model as I said over and over again is exactly the same. We are actually running down the corporate book. So, the corporate book comes down a bit. In the present economic environment, I refuse to move this book forwards. We see too much risk involved and we are too small a bank to take all this.
Reema: What is the breakeven time that you estimate for each branch?
A: We are looking at 20 months, 20-24 months.The Great Diwali Discount!
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