Add Canara Bank Ltd For Target Rs. 147 By InCred Equities
PAT beat on strong non-core income
* Canara Bank’s 2QFY26 PAT beat was due to strong non-core income, while the core performance was in line and asset quality improved sequentially.
* Canara Bank still has a few levers left to offset margin compression with moderation in credit costs, while stake sale gains of its arms to aid profitability.
* Raise our TP to Rs147 (10.5% upside) or 0.9x target multiple on Sep 2027F BV. The risk-reward ratio offers a decent upside despite stretched valuation.
PAT beat on strong non-core income; core performance in line
2QFY26 PAT of Canara Bank at Rs47.7bn (1.1% annualized RoA) beat our estimate on strong treasury income (Rs12.2bn; 30bp of avg. assets, annualized), better-than-expected PSLC income (Rs9.2bn; 20bp), and recovery from written-off accounts (Rs16.8bn; 40bp). Core performance was in line with our estimate. Margin (adj. for IT refund) declined by ~5 bp QoQ to 2.4% and net interest income grew by 2% QoQ, partly helped by avg. balance sheet growth (3% QoQ; 12% YoY). Core fee growth was subdued at 6% YoY (16% QoQ) and the growth in costs was in line, although elevated at 15% YoY. Headline credit costs at 87bp included step-up provisioning on a sub-standard account (20bp). NPA credit costs moderated QoQ (55bp vs. 70bp) and were partly helped by lower net slippage (0.4% vs. 0.5% annualized). Volume growth was strong, with loan book growth at 14% YoY (5% QoQ) & deposit growth at 13% YoY (4% QoQ). The CET-1 ratio stood at 12.2%.
Asset quality improves with moderation in slippage, NPA credit costs
The gross slippage moderated QoQ (Rs21bn vs. Rs22bn). Healthy recovery & upgrades (Rs11bn, steady vs. last quarter) and elevated write-offs (Rs35bn vs. Rs32bn) led to the decline in GNPAs by 8% QoQ to Rs270bn. The GNPA ratio moderated by 34bp QoQ to 2.35%. PCR improved marginally QoQ (77.4% vs. 77.1%). The net NPA ratio moderated QoQ to 0.5%. We expect credit costs to moderate over the next few years, given net NPA level and PCR now in a comfortable range. We have built in credit costs of ~60/65bp for FY27F/28F, respectively, vs. 80bp in FY26F. On ECL, the bank highlighted that the impact could be less than 1% of loans, given that it proactively steps up provision on SMA loans (overall SMA i.e. incl. accounts below Rs50m is ~3% of loans).
Favourable risk-reward with levers aiding profitability yet to play out
We believe Canara Bank is well-placed to offset some margin compression by moderating credit costs over the next few years. It will also benefit from the stake sale/listing of life insurance and AMC subsidiaries in 3QFY26F (~Rs20bn; 10bp of avg. assets). We expect its RoA to moderate to 0.75%/0.8% in FY27F/28F, respectively, from 1.1%/0.9% in FY25/FY26F. The RoE to decline to 12%/13% in FY27F/28F, respectively, from ~15% in FY26F. The risk-reward ratio, at the current valuation of 0.8x Sep 2027F, still offers a decent upside. We have increased our target price to Rs147 (Rs127 earlier) as we roll forward the valuation by six months and revisit our earnings estimates. Maintain ADD rating. Downside risks: Lower-than-expected loan/deposit growth, higher delinquency in retail/MSME portfolios, and a higher-than-expected growth in costs.
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