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Hold Kotak Mahindra Bank Ltd For Target Rs. 2000

Asset quality slips a little; eyes now on regaining growth momentum

* Kotak Mahindra Bank (KMB) reported a beat on PAT at Rs16.4bn (est.: Rs13.9bn), mainly driven by healthy NIMs, higher fees and lower provisions. Asset quality slipped with GNPA ratio up 31bps qoq to 3.6%, a trend seen across banks due to the Covid-induced stress.

* Fresh NPA formation was higher at Rs15bn (3% of loans), mainly due to higher stress in secured products such as CV/CE and mortgages. Specific PCR at 65%/Covid provisions at 0.6% of loans are lower, while ECGLS pool at 5.3% of loans is one of the highest among larger peers, which remains an irritant.

* Credit growth took a back seat in Q1 due to Covid (+7% yoy/-3% qoq) but the bank provided a better outlook on the back of the opening-up of the economy, which should support retail credit growth. KMB’s CASA ratio remains one of the best in the industry at 60%, as reflected in low CoF and thus better margins at 3.6%.

* We trim FY22-24E EPS by 3-5% but retain Hold with a TP of Rs2,000, based on 4x core bank Sep’FY23E ABV and subs valuation of Rs498, given its superior RoAs (~2%), reasonable asset-quality management and strong capital comfort. In our view, incremental stock movement will track growth and asset-quality momentum.

Moderate growth but better outlook:

The credit growth acceleration seen in H2FY21 took a back-seat in Q1FY22, and the bank reported a 3% decline in the loan book, mainly dragged down by corporate and its continued cautious stance in CV/CE and unsecured loans. Growth in the mortgage book remained healthy at 18% yoy/2% qoq, and its strategy is to focus on the salaried customer segment, which offers strong cross-selling opportunities and portfolio quality. Despite cutting the savings rate, CASA grew by 16% yoy/2% qoq and the CASA ratio remained at an industry-best 60%. That said, KMB’s incremental focus will be on accelerating current deposit mobilization, and thus, new branches will be positioned around such clusters. NIM improved by 21bps qoq to 3.6% despite lower LDR due to a sharp reduction in CoF. Kotak remains focused on tapping organic or inorganic opportunities, and is keen on investing in businesses with customer ownership, differentiated capabilities and strength in particular product areas.

Asset quality slips on higher stress in secured retail portfolio:

The GNPA ratio rose 31bps qoq to 3.6% due to the Covid-induced stress, a trend seen across banks. Slippages were elevated at Rs15bn (3% of loans), mainly from secured retail loans, including CV/CE and mortgages. Incremental restructuring was limited, with the cumulative pool standing at Rs5.5bn (0.3% of loans). However, the bank has a higher ECGLS pool at 5%, where it remains confident of better asset-quality outcomes. Although the SMA 2 book increased qoq, it remains low at Rs4.3bn/0.2% of loans. KMB continues to hold a Covid contingent buffer of Rs12.8bn, or 0.6% of loans (vs.0.8% for ICICI/Axis and 0.7% for HDFCB).

Outlook and valuation:

We cut FY22-24E EPS by 3-5% but expect the bank to deliver a strong RoA of ~1.9-2%. RoE should also improve gradually to 12-13% in FY22-24E on a steady increase in leverage, with the bank showing an intent to grow. Retain Hold with a TP of Rs2,000, based on 4x core P/ABV Sep’FY23E and subs valuation of Rs498. Key risks: Higher-than-expected NPA formation, mainly in retail/SME book, failure to deliver on growth expectations and top management attrition.

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