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Our Take:

Federal Bank is one of the best placed mid-tier old private sector bank. The bank has strong granular liability franchise and comfortable capital positioning which can act as a cushion against any uncertain eventuality of asset quality shocks. Federal Bank is changing itself into next-gen private sector bank with digital tie-ups across assets, liabilities, and payments segments. This will not only increase the reach of the business but it will also improve the Cost to Income (C/I) ratio. It is also diversifying into high margin business like retail products, Commercial Vehicle /Construction Equipment loan, micro-credit, credit cards etc. Digital channel adoption and CASA enabling products are improving the CASA ratio of the bank (in Q2FY22, it reported highest ever CASA ratio). The bank has recently hired many senior level leaders across key verticals.

Moreover, the extension of Shyam Srinivasan as the MD & CEO for further three years by RBI has removed the overhang and brought the management stability which many peers lack. NBFC of the bank, Fedfina, is gradually scaling up its loan book and could bring value unlocking for the bank in long run. The bank is trading at comfortable valuations of 1.1x P/ABV FY23E and looking at Bank’s growth strategy the stock warrants re-rating. In last few years, it has focused on accelerating growth in the non-corporate segment and has moderated growth in the large corporates. It has been increasing its focus on higher growth in the retail, SME and agri-gold loan segments. It had also launched its credit card to existing-to-bank customers in the month of May 2021, which can possibly drive fee income and margin improvement in the long run. The bank also plans to scale up its vehicle financing book in the medium term. However, on the retail side, the widening of product basket across high-yield products with adequate size and seasoning will be the key moniterable for improvement in the margin profile in the medium-to-long term.

We had issued Stock update on Federal Bank on 24th May, 2021 and recommended Buy at LTP Rs.85.1 and add on dips to Rs.75 band, for base case target of Rs.94 and bull case target of Rs.103 over the next two quarters. The bull case target of Rs.103 was achieved on 22nd October 2021, yielding return of 21%.

Valuation & Recommendation:

Federal bank has posted decent Q2FY22 results with strong operating performance and lower provisions due to lower loan loss writebacks. On the back of a granular wholesale portfolio and its secured retail franchise, it has reported an impressive asset quality with slippages at 1.1% and steady early stage delinquencies. NPA % is now at a 5 year low. We have envisaged 14% CAGR in Net Interest Income and 24% CAGR in net profit over FY21-FY24E. Further, we have estimated that the loan book would grow at 12.9% CAGR over this period. We expect asset quality and NIM to improve gradually over FY21-24E. There could be higher recoveries in the next two-three years than slippages. The management has guided for Rs.18-20 bn of slippages for FY22. Further, it has guided for Cost to income ratio of 52-53% in FY22 and ~50% by FY23. For RoA, guidance of 1% is by FY22 and 1.25% over the next two years. Potential value unlocking in 74% subsidiary FedFina (balance 26% held by True North) adds to the margin of safety. Fedfina is focused exclusively on small ticket size credits; LAP, gold loans, small business lending. Their lending book is now at Rs.51 bn (vs Rs.44.92 bn as on March 31, 2021) and they are expected to grow at 25-30% a year or more. The net profit of the Company grew by 48% to Rs. 586 mn for the year ended March 31, 2021 as against Rs.395.4 bn for the year ended March 31, 2020. Federal Bank is among the early adopters using FinTech partnerships to build new growth avenues in its effort to boost its profitability, as reflected in recent productivity gains (daily account opening and deployment run rate).

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