Bank on this new-age player

An investment in the banking sector is a proxy bet on the economy.

An investment in the banking sector is a proxy bet on the economy. When an economy is doing well,businesses and individuals tend to borrow more,bank lending goes up,and so does their earnings,and hence,the price of the stock. In recent times,with GDP growth slowing down,banking stocks have also been in the doghouse. Currently,there are concerns that the sector may suffer due to slowing credit growth and rise in non-performing assets (NPAs). But analysts expect the Reserve Bank of Indias (RBI) rate cuts,and the consequent decline in interest rates,to revive demand within the Indian economy sometime in the latter half of FY10. The slew of stimulus packages and rate cuts in the US,UK and other developed-world economies are also expected to do their bit to stabilise the international economic environment. Investors with a long-term investment horizon (of at least three years) should cheery-pick quality banking stocks now,when they are still available at attractive valuations,and wait for the economic turnaround to boost the prices of these stocks. Among private sector banks,Axis Bank has sound prospects.

Strengths

Rapid growth in core activity. Over the last five years,Axis Banks net interest income has grown at a compounded annual growth rate of 49.85 per cent.

Access to low-cost funds. Over the past five years,the bank has grown its CASA (current account savings accounts) market share four-fold from 0.9 per cent to 3.4 per cent. In March FY09,its CASA deposits stood at 43 per cent of total deposits one of the highest levels within the industry. Access to low-cost CASA deposits (banks pay zero interest on current accounts and only 3.5 per cent on savings accounts) is a source of competitive advantage for a bank as it allows it to offer loans at competitive rates and yet maintain its net interest margin (interest charged on loans less interest paid on deposits).

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A high CASA ratio in turn is a function of a banks reach and the trust it enjoys. If a bank has extensive reach in metros,non-metros,and even semi-rural areas,then it can mobilise low-cost CASA deposits. In March 2009,Axis Bank had 827 branches and eight extension counters spread over 515 centres. At 3,595,the bank also has among the largest ATM networks.

Low NPA levels. Because its loan portfolio has grown rapidly over the past five years,there were fears that Axis Banks NPA level would rise amidst the current economic slowdown. But as its Q4 results show,the bank has been able to hold its NPA level down to a reasonable level (net NPA is 0.35 per cent). Gross NPA level for Axis Bank has been 0.9 per cent while for the banking industry as a whole it has been about 2-3 per cent. Says Rajiv Mehta,banking sector analyst at India Infoline: Chances of the banks NPA levels shooting up dramatically in future are also low.

Multiple sources of fee-based income. Axis Bank earns fee income by selling third-party products like mutual funds,insurance,and gold coins to its own customers. The bank is also engaged in placement and syndication of debt issues,forex services,and cash management services. The bank has grown its fee income from Rs 366 crore in FY05 to Rs 2,447 crore in FY09 at a compounded annual growth rate of 60.8 per cent. These businesses promise growing revenues in future also.

Strong management. With the appointment of Shikha Sharma,former managing director and chief executive officer of ICICI Prudential Life Insurance at the helm of Axis Bank,uncertainty about who would succeed P J Nayak has ended. Commenting on the quality of management,Mehta of India Infoline says: The top management has been around for a long time and has delivered the goods.

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Adequately capitalised. The banks capital adequacy ratio (CAR) was a healthy 13.7 per cent,and its tier one capital was a robust 9.3 per cent in March 2009.

Weaknesses

Vaibhav Agrawal,analyst at Angel Broking points out that unlike private sector peers like ICICI Bank and HDFC Bank,Axis Bank does not have a meaningful presence in fast-growing financial services verticals such as life insurance,asset management and broking that are attracting an increasing percentage of overall domestic savings in India. Under its new CEO,let us see if the bank ventures into these financial services verticals,which offer significant opportunity, he says.

Opportunities

The main growth opportunity for Axis Bank will come through expanding its branch network into smaller towns,which,so far,remain the preserve of public sector banks.

Growth prospects

Over the last five years,the CAGR for loan growth for the banking industry has been 25-26 per cent; for Axis Bank it has been above 40 per cent. This pace of growth is expected to moderate somewhat in future. Nonetheless,the bank is still expected to grow its loan portfolio at 1.5-1.7x the industry average. In FY09 its advances grew at the rate of 37.5 per cent. In FY10 they are expected to grow at the rate of 27-28 per cent and in FY11 at 25 per cent. For the banking industry as a whole,the loan book is expected to grow at 18 per cent in FY10 and 16 per cent in FY11. Thus,Axis Banks fast pace of growth is expected to sustain over the next couple of years.

Should you invest?

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Since March 10 this year,banking stocks have rallied. Axis Bank is now trading at Rs 607 (May 8). According to Mehta,There is limited upside left in the stock,especially if you are investing with a six-month horizon. I expect the stock to correct a fair bit in the near future. If you enter it at the Rs 450-500 level and hold it for three years,you can expect to double your investment.

According to Agrawal,At the current market price,the stock is trading at about 2.0x FY2010E book value and 8.9x FY2010E EPS,implying a PEG ratio of 0.6x. Even factoring in worst case estimates of NPAs going forward,at current valuations on P/BV basis there is still margin of safety for investors.

Thus,investors who have the patience to wait for the eventual upturn in Indias GDP growth are likely to be amply rewarded for investing in this stock. u

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