Axis reported Q2 profits a tad below our expectations due to lower treasury gains but its loan growth strength surprised us, especially on the corporate side. Most financial indicators were in line with our core estimates but clearly asset quality surprised positively as slippages were half of the June 2015 quarter. The stock ended the day flattish over the previous close.
Q2 review: Loan growth remained robust at 23% y-o-y, well above system growth, driven by retail (27% y-o-y) and corporate (26% y-o-y), while the SME book growth remained relatively muted. That said, notably, the credit profile for the SME portfolio seems to be improving. Corporate lending was driven by refinancing opportunities rather than capex funding. On the retail side, the Bank aims to balance out the mortgage mix with other non-mortgage credit.
CASA (current account savings account) improved sequentially to 44.2%, driving a margin improvement of 4bp q-o-q (quarter on quarter), also aided by lower retail deposit and wholesale rates. However, we see some risks to these levels of margins being sustained in the near term as base lending rate cuts would likely impact margins before the full impact of deposit rate cuts gets factored in with a lag. Fee income was at 14% y-o-y (year on year), despite 6% y-o-y decline in capital market fees. Asset quality seems to be improving though it doesn’t seem out of the woods just yet. On the positive side, Gross NPL ratio remained stable, restructured loans came down slightly due to upgradations, and credit costs declined sequentially to 85bp. The bank sold Rs 18 bn of power sector loans (standard as of June 2015) to ARCs, at a loss of Rs 12 bn, of which Rs 8.5 bn was absorbed by existing contingency reserves and Rs 3.4 bn was booked as impairment charge in the P&L (profit and loss). These assets sold are over and above management’s earlier guidance of incremental impairments in FY16, which it expected to be lower than that in FY15 at Rs 57 bn. Total impairments so far in the H1 excluding this selldown was Rs 30 bn leaving a maximum of R27 bn to be achieved in the 2H this year. Srinivasan, an existing whole time director on the bank’s board, has been re-designated as deputy managing director and Jairam Sridharan as the CFO.
Earnings outlook: Our estimates remain broadly unchanged. We continue to look for 20-22% loan growth and profitability remaining fairly steady at c1.75% by FY18e implying 19% PAT (profit after tax) CAGR (compound annual growth rate) over the next three years.
Maintain Buy: Axis is currently trading at 2.1x P/AB 12-month forward versus its five-year average of 2.1x P/AB (price-to-book ratio). We continue to value the stock at 2.4x P/ABV and accordingly, we arrive at our TP of R623 (R610) representing 20% upside from the current market price. We maintain our Buy rating. Downside risks to our view include slower-than-expected economic turnaround and higher-than-expected slippages.
Valuation and risks
Buy, Target price R623
We value Axis Bank using a single-stage Gordon growth model based on a weighted average RoE (return on equity) of 19.1% as we cut our earnings estimates due to more cautious outlook on credit costs. We maintain growth rate of 10% and cost of equity of 13.8% leading to a justified P/AB multiple of 2.4x. Our cost of equity of 13.8% is based on 7.5% risk free rate, 5% risk premium, and 1.3 Beta.
