Indusind Bank’s retail loan book is focused on vehicle financing, which constituted 34% of total loans as of March. Its corporate loan book, which formed 59% of its total loans, is focused on funding businesspeople and entrepreneurs across various industries. This allows the bank to maintain granularity in its corporate book, a benefit usually enjoyed on a retail book, which limits exposure to any one large corporation.
Valuation - Fair Value Estimate is Rs 842
We are initiating our coverage of Indusind Bank with an intrinsic valuation of Rs 842 per share. Our fair value estimate represents 3.8 times 2016 book value per share and 19 times our fiscal 2016 diluted earnings per share estimate of Rs 44.26. Our cost of equity assumption of 12% for the company is in line with other Indian banks in our coverage universe.
In our base case, we assume that the firm will increase net revenue (excluding gains on sale of investments) at an average of 23% over the coming five years and earnings at 25% over the same period. The two key assumptions behind our discounted cash flow valuation for the bank are that fee income growth will continue to outpace loan growth as Indusind continues to provide non-fund-based bank guarantees and letters of credit to growing trade businesses. We project noninterest income growth of 24% on average over our explicit forecast compared with 22% loan growth projection over the same period.
We also assume that the incremental branches opened by the bank will not strain its operating cost metrics and continue to drive the efficiency ratio (cost/income ratio) below the 47% recorded in fiscal 2015 to average at 43% over the following five years. Furthermore, we believe the niche areas where the bank has decided to focus will allow it to expand NIM further to 4%-plus levels shortly. The fixed-rate vehicle loan book will allow Indusind to maintain yield on its assets, while its growing CASA deposit base will lower funding costs, thereby expanding margins in the coming years. Overall, we are optimistic about the growth and profitability prospects of this narrow-moat bank.
Economic Moat - Narrow
Indusind Bank's narrow economic moat rating is based on substantial cost advantages and high customer switching costs, allowing the bank to generate incremental returns on equity in excess of our 12% estimated cost of equity. As with most banks, Indusind Bank's moat is derived from its low loan losses, low operating costs, low funding costs, and switching costs developed from cross-selling other products, which help generate high fee income. In Indusind's case, the average cross-selling ratio is 3.2 products per customer, which means that an average savings account customer or a borrower will subscribe to three other fee-based services from the bank, such as wealth management services, insurance, mutual fund, or credit cards.
The bank's provisions as a percentage of loans averaged 80 basis points over the past five years (which is better than HDFC Bank's 1.0%, Axis Bank's 1.1%, and SBI's 1.2% over the same period), proving that it has sound underwriting skills and maintains a healthy loan book. The lower loan losses are also a result of its balanced approach of a 50/50 split between retail and wholesale loans, which prevents the bank from taking undue risk on any one segment.
In addition, the bank has excellent control over its operating costs and maintains an efficiency ratio (noninterest expense/revenue) of 45%-50%, which we believe is reasonably good as its 801-branch network delivers approximately Rs 0.9 billion of deposits per branch, which is comparable with the other private banks that garner close to INR 1.0 billion per branch.
Also, its deposit base, which is about 10% larger than its loan book, allows Indusind Bank to fund its balance sheet while earning a comfortable 3.4% average NIM over the past five years. This NIM is in line with those of other players, such as SBI's 3.3% and Axis Bank's 3.4%, over the same period. The bank garnered 25% of its fiscal 2015 revenue from fee-based services, which compares with 30% for most other banks, but is still impressive given that it generated under 20% in fee revenue/total revenue in 2008.
Overall, thanks to good underwriting and cost-efficient operations, Indusind Bank has earned average returns on equity of 17% over the past four years, well above our 12% estimated cost of equity, confirming our narrow economic moat rating.
Stewardship - Standard
We believe Indusind Bank is a standard steward of shareholder capital. The bank has been able to increase net revenue (excluding gains on sale of investments) at a 34% compound annual growth rate over the past five years and earnings at 39% over the same period by continually finding higher-yield assets to invest its growing liability franchise in. It has achieved this without taking incrementally higher risk, as gross nonperforming loans have moved from 3% of total loans in 2007 to under 1% in 2015. Indusind has been able to garner low-cost funds by offering higher interest rates on savings deposits of 5.5% versus 4% offered by the larger banks--ICICI Bank, HDFC Bank, and State Bank of India. Its focus on trade-related businesses has also allowed it to expand its current account liabilities as its customers' business grows. In 2015, the bank's current accounts and savings accounts accounted for 34% of its total deposits (nearing the 40%-plus levels for its larger peers) compared with just 15% in 2007. This shows that the bank has executed well on its strategy of carving out its niche while establishing the four pillars of its narrow economic moat rating sourced on cost advantages: low credit costs, low operating costs, low funding costs, and high fee income component.
Romesh Sobti, the CEO and managing director of Indusind Bank since February 2008, has over 33 years of banking experience across state-run and private international banks. He and his five colleague bankers from ABN Amro have been responsible for the turnaround of the bank. Indusind, which received its banking license in the same year as HDFC Bank, has a net worth that is one fourth that of HDFC Bank today. Management has achieved this with minimal capital raising; the last big capital raise for the bank was in December 2012 through a qualified institutional placement, which has yielded good returns for investors.
The bank has undertaken some business acquisitions in the past, which in our opinion have helped it reach a position of strength today. For example, the merger of Ashok Leyland Finance in 2004 brought it the commercial vehicle financing business, which continues to be its mainstay. Through the 2015 acquisition of Royal Bank of Scotland's diamond and jewelry business in India, management is gaining access to a book it had experience handling during its time at ABN Amro, and one that will aid future fee income growth. We view both these capital-allocation decisions as wise.
The firm has paid out 10%-15% of its earnings as dividends to shareholders in the past five years, which we think is reasonable. Overall, we laud management for the results it has been able to generate in the eight years since the erstwhile ABN Amro team took the helm.
