We lift Kotak to Buy as we think the recent 20% correction provides investors with a good entry into a high-quality bank. After the ING Vysya acquisition, investors’ expectations seemed high. However, we think Q1FY16 integration charges partially explain the lower acquisition cost and also set investors’ expectations on growth and asset quality lower.
We think Kotak’s earnings quality remains one of the best in the sector. Our target price of R750 implies 3.8x FY17F BVPS of R173.
Merger cost taken; synergies to follow Kotak upfronted R3 bn of ING-related integration charges (18% of ING Vysya’s net worth) explaining the lower 2.2x valuation on the merger. While in the next 1-2 quarters part of these charges should continue, we expect significant synergy benefits after that: 1) lower opex cost; 2) CASA uptick in ING’s book and 3) better quality growth in ING’s book. Combined ROAs should fall to 1.5% in FY16F from 1.9% in FY15 due to integration but ROAs to revert to ~2% by FY17F.
Earnings growth remains superior: The quality of Kotak’s CASA and fee growth remains superior with CASA accretion being more granular than peer banks and contribution of bulky IB and debt syndication being smaller. As well, our exposure analysis suggests that risk to Kotak’s asset quality is very low and with R10bn of provisions taken on ING’s book, we think risk to credit costs of the combined entity is also low.
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