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High growth aspirations with focus on sustaining high RoAs across cycles

Federal Bank (FB) hosted its Analyst Day on 28-Feb-2023, offering an update on the progress till date as well as future growth plans encompassing increasing share of high-margin products (currently at 21%), fortifying market leadership in select products, improving core fees and operating leverage to sustain higher RoAs. KTAs from the event are:

* Bank re-orienting its loan portfolio towards high-yielding loans, without compromising on quality: FB seems more confident about delivering growth, coupled with better margins and thus higher RoAs. While it expects credit growth of 18-20% in FY23 and a mid-to-high teen growth in the medium term, it would not hesitate to put the pedal to the metal, as & when opportunity arises, for accelerating growth. Retail and SME/Commercial banking will remain the key growth drivers, while incremental focus will be on upping the share of unsecured loans from current 7% including CC/PL to drive up margins (>3.2%). FB aspires to make place among the top-7 players in the cards business by 2024. On the secured front, high-margin products like Gold loan (to double in 3 years), MFI (to double by FY26E, from the current Rs10.5bn) and CV/CE (including pre-owned share to increase to 20%, from the current 4-5%) would also see quicker growth

* Lite Branch, heavy distribution, higher digitization and subsidiary support to improve operating leverage: After a long lull, FB is primed to add 75 smart branches during FY23, predominantly in non-Kerala markets (including Tamil Nadu), while further enhancing its RM base (currently at 937, up from 113 in the past 3 years) to distribute asset/liability and fee products. Led by a dedicated team, FB has built a strong fintech partner ecosystem across business lines based on its business contribution (Incremental Savings deposits: 19%; Cards issued: 25%; PL disbursed: 36%), and would consider new partnerships as well as scale up business from existing partners. FB’s subsidiary FedServ has now received RBI approval for sales management, collections and IT support, which should help manage cost amid business ramp-up

* Core-fee improvement to endure; PSLC to emerge as a new opportunity: The Bank has seen healthy core-fee growth on the back of strong growth in the retail segment and traction in forex/TPD fees. FB believes that its enhanced product offering and deepening customer engagement should help boost core fees, thereby reducing the gap with peers, including with some of the large banks. FB is now PSL-positive and surplus should be available for selling down and generating fees. The Bank’s treasury performance too has been far better than peers which should continue going forward.

* We retain BUY: Despite a protracted difficult phase, Federal Bank has been consistently delivering on growth and margins as well as RoA of over 1.2%. We believe that FB’s focus on the high-margin asset portfolio and fee/cost management, while containing lower LLP, should help deliver healthy RoA/RoE of around 1.3%/16% by FY25E (without factoring-in the capital raise). The Bank would also look to launch the FedFina IPO at an opportune time as well as to mobilize growth capital. We retain BUY on the stock, with TP of Rs185/share (valuing the standalone bank at 1.5x Dec-24E ABV and subsidiary at Rs8/share), which provides a decent >40% upside. We believe Federal Bank offers an attractive investment opportunity (trading at 1.1x FY24E/1x FY25 ABV) in the USD3-4bn market-cap space within the financial sector.

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