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Business growth picking up, earnings outlook stays strong; Buy

CUB’s Q2 FY23 profitability improved, with 1.72% RoA (up 26bps q/q) and better asset quality. Key positives were 1) a pick-up in loan growth, 2) strong recoveries, 3) expansion in margins and 4) strong liquidity and capitalisation. Ahead, we expect slippages to ease further and earnings to improve. We maintain a Buy, at a TP of Rs220 (earlier 190), valuing it at 1.7x P/ABV on its FY25e book.

Asset quality stable. Slippages for the quarter were Rs2.6bn (2.5% of loans), slightly lower than the previous quarter. Higher write-offs and strong recoveries counter-balanced elevated slippages, leading to a 29bp sequential improvement in GNPA to 4.36%. With the bulk of the accounts (stressed on account of Covid’19-related restrictions) already delinquent/restructured in the last 3-4 quarters, we expect slippages to be normal from now. We expect GNPA in the next three quarters to come down ~70bps from current levels to 3.6%. The standard restructured book declined ~3% q/q to Rs19.6bn (~5% of the loans).

RoA should be sustainable above 1.5%. With ~68% of the bank’s book linked to EBLR, margins should be maintainable at current levels (4%+) as transmission in yields would be faster than costs even with a further increase in interest rates. High-teen growth combined with strong operating profits would keep RoA above 1.5% levels in the medium term.

Valuation. Our Nov’23 target of Rs.220 is based on the two-stage DDM model. This implies a ~1.7x P/BV and ~1.8x P/ABV multiple on its FY25e book. Risks: Higher slippages, lower-than-expected loan growth.

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