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Business growth steady; valuations reasonable

Operating leverage to drive RoE recovery

* DCB Bank (DCBB) has seen a healthy recovery in loan growth over the past two years after reporting tepid trends over FY20-22. The bank continues to focus on granular retail loans, with the share of mortgages rising to 45% from 41% in Mar’22.

* DCBB has maintained NIMs within a healthy range of 3.6-4.0%, aided by a granular liability profile, limited reliance on bulk deposits and an improving asset mix as the bank has strategically reduced the mix of low-margin corporate loans.

* While opex has been high owing to investments in business, we expect operating leverage to kick in, pushing RoA toward 1%. We believe the C/I ratio has broadly peaked out at 64% in FY24 and expect it to moderate to ~60% by FY26E.

* We expect a healthy 19% CAGR in revenue over FY24-26E amid stable margins and steady loan growth. We estimate RoA/RoE to reach 1%/14% by FY26 (FY24 RoA: 0.9%).

* We had downgraded our rating on DCBB to Neutral in Jul’19 (stock price at INR239) amid weaker operating performance and an uncertain growth/asset quality outlook. However, with a recovery in loan growth and anticipated improvements in operating leverage, we estimate a 21% earnings CAGR over FY24-26E.

* We, thus, find the current valuations at 0.7x FY26E ABV attractive and accordingly upgrade our rating to BUY from Neutral, with a revised TP of INR175 (0.9x FY26E ABV).

Loan growth to sustain at 19% CAGR after a blip in FY20-22

DCBB management has oriented its business strategy to generate more business from its existing branch network while investing in digital capabilities to enhance the customer experience at branches. The bank is seeing a healthy recovery in loan growth over the past two years after reporting tepid trends over FY20-22. The bank continues to focus on granular retail loans while also increasing the mix of business loans to deliver profitable growth. The bank has increased the share of mortgages in its book, which now form 45% of the overall portfolio. We estimate the bank to deliver an 18% CAGR in its overall balance sheet for FY24- 26E, with advances and deposits garnering a 19-20% CAGR in the same period.

Retail mix rising; branch expansion to aid business growth

DCBB has put in conscious efforts to make the loan book granular and has curtailed its exposure to the lumpy corporate segment. Over the past two years, the bank has further increased the mix of mortgages and AIB segments by ~800bp to ~70%, while the mix of corporate and SME has declined. DCBB, under the leadership of new MD, Mr. Praveen Kutty, remains focused on delivering steady growth with a focus on retail and business loans. The bank is gradually expanding its branch network by adding 15-20 branches each year through a cluster-based approach and increasing ground staff to support growth momentum. It is focusing on improving productivity and efficiency at existing branches in states with many untapped SMEs and good potential for CASA mobilization. Consequently, the bank aims to double its balance sheet size over next 3-4 years, matching the historical run rate.

Estimate NIMs to stabilize at ~3.65%

NIMs have been maintained in the healthy range of 3.6-4.0%, despite a lower CASA ratio of 26%. Several key factors have contributed to this stability, including a granular liability profile, limited reliance on bulk deposits and an improving asset mix, as the bank has strategically reduced the mix of low-margin corporate loans. The bank offers higher rates on higher ticket sizes to attract SA customers; however, the bulk of savings account balances come at the lower end of the pricing range. With deposit re-pricing largely complete, we expect funding costs to remain broadly under control and we believe that SA rate remains a lever that the bank can use to maneuver its funding costs as and when the rate cycle turns. We thus estimate margins to sustain at ~3.65% over FY25-26E, while the CASA mix remains broadly stable.

Revenue growth to lead opex growth; estimate C/I ratio to decline to ~60%

DCBB has made aggressive investments in business to enhance the franchise, which has resulted in a sharp rise in the C/I ratio. Consequently, opex growth over the past three years has dwarfed revenue growth, leading to a sharp deterioration in the C/I ratio to 64% (FY18-20 average of 57%). As branches mature and loan growth remains steady, DCBB expects enhanced productivity leading to lower opex growth and an improved C/I ratio. Investments in digital capabilities and branch network optimization are key strategies to enhance customer experience and improve operational performance. We estimate opex growth to moderate to 15% CAGR over FY24-26 (vs. 22% CAGR over FY21-24) as operating leverage in the business improves. The C/I ratio is thus anticipated to decline to 60% by FY26 vs. 64% in FY24.

Asset quality outlook healthy; GNPA to improve further

During the Covid phase, the bank experienced asset quality pressure as GNPA deteriorated. However, the bank has corrected its course by focusing more on underwriting quality. The portfolio is now mostly secured, well-diversified, and increasingly granular. Moreover, revamped collection and recovery mechanisms and a streamlined credit appraisal process have improved asset quality. While restructured book still remains relatively elevated (INR10.7b; 2.6% of loans), we expect slippages to remain under control, led by continued growth in secured retail, SME, and agri/microfinance sectors. We estimate GNPA/NNPA ratios to improve to 2.6%/0.8% by FY26 and estimate credit costs to sustain at 0.5% in FY26E.

Valuation and view: Upgrade to BUY on reasonable valuations

DCBB has seen a healthy recovery in loan growth after witnessing sluggish trends during FY20-22. The bank's shift in loan mix toward retail loans has not only shielded its margins but also provided stable, profitable growth. The bank has made significant investments in the business and is well poised to sustain the healthy growth rate, while improvement in operating leverage helps sustain RoA at ~1% by FY26E vs. 0.9% in FY24. We, thus, estimate RoE to recover toward ~14% by FY26E vs. average 10% over FY22-24. We had downgraded our rating on DCBB to Neutral in Jul’19 (stock price at INR239) amid weaker operating performance and an uncertain growth/asset quality outlook. However, we find the current valuations at 0.7x FY26E ABV attractive in context to a ~21% earnings CAGR estimated over FY24-26E. We, thus, upgrade our rating to BUY from Neutral, with a revised TP of INR175 (0.9x FY26E ABV).

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