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Strong earnings beat; building of provisioning buffer positive

* Despite moderate credit growth and elevated provisions, Canara Bank reported a strong beat on PAT at Rs11.7bn (vs. est. Rs7bn), driven by strong margins, a one-off gain from the UB group stake sale and higher PSLC fees (seen across PSBs). Reported GNPA improved 43bps qoq to 8.5% due to contained slippages/higher upgrades.

* Restructured pool has doubled qoq to Rs183bn, 2.9% of loans, with a major contribution from retail, which is a bit concerning. The bank guides for FY22 slippages to be ~2.1-2.3% and expects higher recoveries from resolutions in some lumpy corporate accounts. CBK has identified NPAs to the tune of Rs51.5bn (0.8% of loans) to be transferred to NARCL.

* CBK has started building up a provision cover, which has been an irritant. Its specific PCR now stands at 61% and the Covid-related buffer at Rs13.4bn (0.2% of loans). However, CET 1 is sub-par at 8.9%, and thus the bank may consider raising capital soon.

* In our view, merger/asset quality related concerns are largely behind and the bank should report a gradual improvement in its RoA/RoE to 0.4-0.5%/10-11% by FY23E-24E (without factoring in dilution). Retain Buy with a revised TP of Rs185 (from Rs175), factoring in upgrades in earnings/multiple (core bank now valued at 0.6x vs. 0.5x).

Focus to shift to growth, and thus better LDR feeding into NIMs:

Credit growth was moderate at 5% yoy/1.5% qoq to Rs6.5trn, mainly due to corporate debulking and continued tepid growth in MSME (up 1.9% yoy/ down 1.3% qoq). The retail lending portfolio clocked 9.6% yoy growth, led by housing and vehicle portfolios. Deposit growth was strong at 12.3%yoy/1.1%qoq, leading to lower LDR. However, reported NIMs improved 21bps qoq to 2.7% due to better yields, lower CoF and interest reversal on NPAs. Given the asset quality stress largely behind, management has guided for a better growth trajectory. With CET 1 at a sub-par level of 8.9%, management has taken enabling resolution to raise capital via QIP.

Elevated stress, but building a provision buffer which otherwise has been an irritant: :

Headline asset quality has improved 43bps qoq, with GNPA ratio at 8.5% due to contained slippages and higher upgrades. Restructuring book stands at Rs183bn (Corporate- Rs43bn, MSME- Rs33bn and Retail and SBL- Rs96bn), 2.9% of loans. Specific non-technical PCR has inched up to 61% from low 40’s earlier, which is comforting. CBK has provided an additional Rs8.4bn during the quarter, resulting in a cumulative Covid-related buffer of Rs13.4bn (0.2% of advances). CBK expects both credit cost and slippages to be in the range of ~2.1-2.3% for FY22.

Outlook and valuations:

We believe that merger-related concerns are largely behind and the bank should report a gradual improvement in its RoA/RoE to 0.4-0.5%/10-11% by FY23E24E (without factoring in dilution), led by better growth and moderate LLP. Retain Buy with a revised TP of Rs185 (from Rs175), factoring in upgrades in earnings//multiple (core bank valued at 0.6x vs. 0.5x). Key risks to our call/estimates: Higher-than-expected NPA formation, a slower growth trajectory and a sharp rise in G-Sec yields leading to lower treasury gains.

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