Buy City Union Bank Ltd For the Target Rs.275 by Axis Securities Ltd
Strong Quarter; Consistent RoA Delivery of Over 1.5% to Continue!
Est. Vs. Actual for Q2FY26: NII – BEAT; PPOP – BEAT; PAT – BEAT
Changes in Estimates post Q2FY26
FY26E/FY27E/FY28E (in %): NII: +4.6/+3.6/+3.8; PPOP: +2.9/+0.9/+1.3; PAT: +6.9/+1.8/+2.2
Recommendation Rationale
* Growth Visibility Healthy: CUB’s growth engine has started to fire, with credit growth at a decadal high (+18/7% YoY/QoQ in Q2), and the management is confident of the momentum to continue, supported by healthy growth visibility in the MSME and Gold segment, and a gradual ramp-up of the retail segment. Despite robust growth delivery in H1FY26, significantly above industry growth, the management has reiterated its guidance of maintaining credit growth 2- 3% over industry growth, which we believe is conservative. However, the bank is not averse to accelerating the pace of growth without compromising on asset quality. The bank is on track to ramp up its retail portfolio, supported by its branch network (90% mix) and the DSA channel (10% mix), and expects to break even in FY26 and turn RoA accretive from FY27 onwards. The bank has financed loans of more than Rs 500 Cr so far towards renewable energy and plans to scale the book to Rs 2,500 Cr over the next 24-30 months. We expect sustained momentum in the Gold and MSME book, along with support from a gradual ramp-up in the retail portfolio to support CUB’s healthy credit growth delivery of ~16% CAGR over FY26-28E.
* NIMs Surprise Positively; H2 NIMs to Move With a Positive Bias: CUB has been able to improve its NIMs by 9 bps QoQ in Q2, supported by downward repricing of deposits, migration of the gold loans to the fixed rate book, and repaying high-cost borrowings. Going ahead, the management expects ~45-50% of the overall deposit book (with Rs 17,000-18,000 Cr worth of TDs) to reprice, driving CoF lower. The headwinds on yields are largely behind, barring any further rate cuts. Thus, limited pressure on yields, lower CoF with continued deposit repricing, and benefit accruing from CRR cut should drive NIM improvement over H2, keeping NIMs in line with management guidance of current level +/-10 bps. We expect NIMs to settle at ~3.6-3.7% over FY26-28E.
* No Major Asset Quality Concerns; No Adverse Impact of US Tariffs: The management has guided for a negative net slippage trend to continue over H2, thereby keeping credit costs under control. CUB has made a provision of Rs 100 Cr during the quarter, anticipating the ECL transition. Furthermore, the bank does not expect any stress due to the impact of US tariffs on the MSME borrowers, with exposure to US exports in the textile, gems and jewellery, and food processing industry low at 0.27% of the total loan book (at Rs 154 Cr). Within this pool, exposure to the textile segment is negligible at 0.12%, and interactions with borrowers provide comfort, showing no indications of risk. With no major asset quality challenges in sight, we expect credit costs to remain under control and range between 50-55 bps over FY26-28E.
Sector Outlook:
Positive Company Outlook: We expect CUB’s superior RoA delivery on 1.5%+ over the medium term to continue, supported by (1) Buoyant growth sustaining with strong growth visibility in its core segments and further support from the retail portfolio ramp-up, (2) Ability to deliver strong NIMs, and (3) Consistently improving Asset quality, keeping credit costs under control. With margins bottoming out and moving with a positive bias alongside benign credit costs with strong asset quality trends persisting, we expect CUB to deliver a strong ~16% CAGR growth over FY26-28E in NII/Earnings.
Current Valuation: 1.8x FY27E ABV; Earlier Valuation: 1.8x FY27E ABV
Current TP: Rs 275/share; Earlier TP: Rs 270/share
Recommendation: We maintain our BUY recommendation on the stock. Alternate BUY Ideas from Our Coverage
Alternate BUY Ideas from Our Coverage
DCB Bank (TP: Rs 170); IDFC First Bank (TP: Rs 83); Federal Bank (TP: Rs 265)
Financial Performance
* Operational Performance: CUB’s advances growth was ahead of our estimates (+18/7% YoY/QoQ) and was led by healthy growth in the gold book and MSME segment. Deposits growth also improved to 21/6% YoY/QoQ, led by strong growth in TDs (+23/5% YoY/QoQ) and CASA deposits (+16/9% YoY/QoQ). CASA ratio stood at 27.3% vs 29.5/28.5% YoY/QoQ. C-D Ratio stood at 82.8% vs 82.2% QoQ.
* Financial Performance: NII grew by 14/7% YoY/QoQ with NIMs improving by 9 bps QoQ with a 24 bps drop in CoD adequately offsetting the yield compression of 15 bps QoQ. NIMs stood at 3.63% vs 3.67/3.54% YoY/QoQ. Non-interest income grew by 14/6% YoY/QoQ, driven by healthy fee income growth (+29% YoY). The bank reported a treasury gain of Rs 22 Cr vs Rs 64 Cr QoQ. Opex grew by 20/9% YoY/QoQ, and C-I Ratio inched up to 49.2% vs 47.1/48.1% YoY/QoQ. PPOP grew by 10/4% YoY/QoQ. Credit costs declined YoY/QoQ by 19% each and stood at 41 bps vs 52 bps QoQ. PAT grew by 15/7% YoY/QoQ. RoA improved to 1.6%.
* Asset quality continued to improve with GNPA/NNPA at 2.42/0.9% vs 2.99/1.2%, led by lower slippages and strong recoveries. Slippage ratio improved to 1.1% vs 1.5% QoQ.
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