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Improving Cost-to-Income ratio to boost ROE

IDFC First Bank, founded by the merger of erstwhile IDFC Bank and erstwhile Capital First on December 18, 2018. At present, the bank’s total number of branches stands at 809, with total funded assets of Rs.1,60,599cr.

* Net Interest Income (NII) reported a growth of 35% on a YoY basis, with strong growth in both advances and deposits.

* Cost-to-income (C-I) ratio is expected to improve further, taking ROE above 14% by FY25.

* The bank has been successful in shifting its advance mix through retail focus and has made a considerable reduction in its corporate/infrastructure book.

* Asset quality improved further with GNPA/NNPA at 2.51%/0.86% compared to 2.96%/1.03% during previous quarter. Provision Coverage Ratio (PCR) improved to 80.3%.

* We value the stock at 1.6x Adj. BVPS of FY25E with a target price of Rs.75 and recommend Buy rating.

Broad based improvement aided stellar earnings

In Q4FY23, Net Interest Income (NII) reported growth of 35% on a YoY basis and 10% sequentially, aided by strong business momentum and margin expansion. Interest income witnessed a growth of 41% YoY and 9% QoQ, while interest expense grew by 50% YoY/8% QoQ. The reported NIM for the quarter improved 28bps sequentially to 6.41%. The high cost legacy borrowing has run down from Rs.25,180cr to Rs.17,673cr. About Rs.5,000 cr of additional rundown is expected in FY24, and the entire book is expected to be cut down by FY26. Repricing these with low-cost deposits will help reduce the cost. The bank could successfully bring down the cost-to-income ratio from 77.8% in FY22 to 72.5% in FY23. Management is confident in bringing down the cost further as both liabilities and credit card businesses that have a higher C-I ratio are expected to normalise as the businesses get scaled-up. As a result of these all-round improvements, the pre-provision profit of the bank grew by 89% YoY and 24% QoQ. The credit cost of the bank came in at 1.26% for Q4 and 1.16% for FY23, well below the guided 1.5%. The net profit of the bank grew 134% YoY and 33% QoQ to Rs.803 cr.

Deposit grew at an exceptional 47% YoY

The bank has accelerated its growth with a focus on retail advances. Gross funded asset of the bank grew by 24% YoY to Rs.1,60,559cr during the quarter, with retail loan book constituting 79% of the book. While deposits grew at an exceptional pace of 47% YoY. The advance and deposit books are expected to grow by 24% over FY23-25E. The CASA ratio of the bank stood at 49.8%, compared to 50.0% in the previous quarter. The capital adequacy of the bank stands at 16.8%.

Improvement in asset quality

Asset quality has also witnessed sharp improvement, with GNPA/NNPA recording a sequential reduction of 45 bps/17 bps to 2.51%/1.03%. The retail segment, which constitutes 79% of the total book, has a GNPA/NNPA of 1.65%/0.55%. Collection efficiency was consistent at 99.5% during the quarter. Overall Provision Coverage Ratio improved to 80.3% The credit cost is expected to stay below 1.5% in the coming years.

Outlook & Valuation

With strong support from the retail segment, both deposits and advances are witnessing stellar growth. We expect both to deliver 24% growth over FY23- 25E. The cost-to-income ratio, which was a major overhang for the bank, is showing consistent improvement. It is expected to improve further as the business scales up. Additionally, the substitution of legacy high-cost borrowings with low-cost deposits will support the margin. Both of these factors will take ROE above 14% by FY25. We value the stock at 1.6x FY25 Adj. BVPS to arrive at a target price of Rs. 75 and recommend ‘Buy’ rating.

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