IDFC Limited
IDFC's fiscal 2015 earnings fell by 5% as the firm began spending significant cash to set up its banking franchise, while simultaneously dealing with a cyclical downtrend in infrastructure lending. Earnings were below our forecast 1% decline, primarily reflecting employee expenses (up 35%) as the firm hires experienced bankers to lead its banking arm, and other expenses (up 69%) to set up the technology and services infrastructure needed to run a bank.
These expenses were inevitable given the shift in focus from being infrastructure lender to a retail bank. We await more clarity on what strategy the firm will adopt to build its retail franchise and attract retail deposits, the most important part of a retail bank puzzle if IDFC is to earn good returns over the long term and build funding cost advantages, as well as switching costs.
We believe it is important IDFC balances the opening of new branches and use technology-based initiatives to reach the Indian audience in its new banking avatar.
The firm's net interest income declined 3% on an 8% fall in the loan book, while net restructured loans rose by 8% during past year. Net interest margin fell 60 basis points to 3.4%, as IDFC limited infrastructure disbursements, except to the higher-rated corporates where competition is intense. This confirms our no-moat rating on the company, as we believe IDFC needs to carve itself a niche in lending, with specific clientele to be successful as a bank, and build competitive advantages over the longer term which can protect profit and returns.
As it becomes a bank in October 2015, the firm will begin to diversify its loan book. Despite the usual start-up pains IDFC is experiencing, we believe the retail deposit franchise is a key aspect the firm must get right before we can say it is on its way to developing an economic moat. The stock continues to trade at a discount to our estimate fair value, as much needs to be seen on how IDFC performs on its new challenge.
To read a detailed analysis on IDFC, click here.
Also read, IDFC’s change in fair value
Axis Bank
Axis Bank's fourth-quarter and fiscal 2015 earnings grew in line with our 18% growth forecast. Retail loan growth, fee income growth, and good loan underwriting all helped the tide the firm over a quarter when other banks have been reporting higher loan write-offs and nonperforming assets. We remain positive on the quality of the bank's loan book and strong operating efficiency.
Returns on equity of 19% for the year and 21% for the quarter are trending several notches higher than our estimated 12% cost of equity, reaffirming our narrow economic moat rating.
Outstanding loans for the bank grew 22% over last year, ahead of our 17% estimate, aided by retail loans, which grew 27% and account for 40% of total loans. Despite strong loan growth, the bank maintained its NPA ratio at 0.44% and credit costs below 100 basis points of total loans for the year. Fee income grew 19%, aided by retail fees (up 29%, accounting for 39% of total fees) from third-party distribution of mutual funds and insurance products as well as more loan customers and credit card transactions.
The bank continues to maintain a low cost/income ratio of 41.5% for 2015. Axis has a network of 2,589 branches while peers such as ICICI Bank and HDFC Bank have crossed the 4,000-branch mark and continue to increase their network by 10% per year. Axis remains cautious about expanding its physical branch numbers, and we see this prudent approach as appropriate, given that the number of transactions made in the branch have declined 3% over last year, compared with 17% growth in online transactions for Axis.
Our fair value estimates of Rs 531 and $43 are unchanged. With the share price currently trading close to our fair value estimate, we would prefer to wait for a larger margin of safety before building a position in the stock. A buying opportunity could present itself if sentiment in the capital markets turns temporarily.
To read a detailed analysis on Axis Bank, click here.
Also read, Axis Bank’s change in fair value
HDFC Bank
HDFC Bank’s fourth-quarter fiscal 2015 earnings grew by 20.6%, in line with our full-year estimates. Provisions were higher than anticipated, with the bank selling Rs 5,500 million in gross loans from a specific corporate account to an asset reconstruction company ahead of the loan going bad. The majority of this was provided for from floating provisions of the bank. During the conference call, HDFC Bank’s management shared that other peers lending to the same entity are yet to recognize this account as a bad loan. These actions on its loan underwriting and bad loan recognition support our Exemplary stewardship rating.
Overall, HDFC's shares look fairly priced, trading at a modest discount to our fair value estimate of Rs 1,050 per share. Our outlook remains upbeat as far as quality of book and high earnings growth is concerned, projecting gross non-performing loans below 1% and earnings growth of 20% during the next five years.
As the bank continues to improve market share (albeit only 4% of the Indian market) and grow its loan book faster than the market, we harbor a favorable view of the bank's future prospects. We believe the bank will continue to earn return on equity of 20% or higher over the coming decade, reaffirming our narrow economic rating. The recent equity raise has provided the company with an adequate run rate for the next four to five years, with Tier 1 and capital adequacy ratios at 13.7% and 16.8% as of March 2015, respectively.
The bank’s low-cost liability franchise continues to grow strongly despite the fact that it offers lower savings rates than most of its newer competitors. HDFC's 4% deposit rate is similar to other large banking peers, but lower than Kotak’s 6% or Indusind 5.5%. As of March 2015, HDFC Bank’s deposits grew by 23% over prior year, and ahead of loan growth of 21% over the same period, driven by its brand and customer stickiness.
The bank also continues to maintain a high cross-sell ratio of its products, building in further stickiness with its existing liability customers. The bank continually earns 30% of its total income from fee based noninterest income. This revenue continues to grow on the back of buoyant market conditions, as fees on transactions and commissions earned on market-linked products, such as mutual funds, investments, and derivatives transactions, account for a large proportion of this revenue.
In order to expand its reach to the non-urban part of India, the bank increased its branch number by 18% this year to total 4,014 branches. Despite this large expansion, its cost-to-income ratio dropped by 100 basis points, to 44.6% for fiscal 2015. We believe the bank has already reached adequate scale of operations to reap the benefits of operational leverage. While the branch expansion by such a large number is surprising, given that a significant proportion of HDFC Bank’s transaction now take place through alternate channels. Management's strategy is to continue to spend on technology and mobile initiatives, but they believe complete branchless banking is still some ways away in India.
To read a detailed analysis on HDFC Bank, click here.
Also read, HDFC Bank's change in fair value.
ICICI Bank
ICICI Bank’s consolidated fourth-quarter earnings growth of 13% was broadly in line with our expectations.
Higher net interest margins boosted interest income, and strong growth in insurance premiums supported earnings growth despite the higher-than-anticipated loan provisions. On the interest income front, the bank relied less on wholesale funding and focused on improving the proportion of more profitable current accounts and savings accounts to 46% of total deposits, versus 43% the prior year. Loans grew (up 14%) ahead of deposits (up 9%), which also helped margins. Disappointingly, the bank’s net nonperforming assets as a proportion of total loans was 1.4% as of March 2015 compared with 1.12% just three months back in December 2014. While management had guided for a higher ratio this quarter, the 1.1% ratio of provisions/loans for fiscal 2015 was still higher than the 1.0% accounted for in our fiscal 2015 forecasts.
We continue to watch quality of underwriting carefully and remain hopeful that provisions/loans ratio will be limited to 1.0% over the longer term, by a gradual improvement in risk management at the point of origination itself. We believe the firm is a standard allocator of shareholder capital.
Despite the disappointing performance on the loan loss front, we are upgrading our economic moat rating on the business to narrow from none. This is in light of ICICI Bank’s life and general insurance businesses reaching scale, thereby sustainably improving the firm’s return on equity above our threshold 12% cost of equity assumption. On a consolidated basis, the bank now displays cost advantages when it comes to reasonable loan losses, low cost of operations, low funding costs, and a high proportion of noninterest or fee-based income.
Our five-year average earnings forecast growth of 15% remains intact, supported by strong loan growth of 12%. We believe the shares are fairly valued, trading near our Rs 327 intrinsic value.
To read a detailed analysis on ICICI Bank, click here.
Also read, ICICI Bank's change in fair value
