Federal Bank, with a well-diversified loan portfolio, is progressively penetrating in states like Maharashtra, Gujarat, Tamil Nadu, Karnataka and Punjab apart from deepening its reach in Kerala. Sizeable gold loan portfolio (not linked to base rate) and strong traction in other retail products and SME business would support lending yields during interest rate down cycle. On the other hand, consistent improvement in CASA ratio (significant branch additions in CASA accretive locations), decline in proportion of high-value deposits (11% as on Decâ€™2012) and relatively higher proportion of low-cost deposits (41.7%; includes CASA, NRE SA, NRO SA and FCNR) would lower cost of funds. Stress in SME and Retail segments is moderating with signs of improvement in delinquency rate. Further, with a large portion of distressed corporate accounts having been declared NPA or restructured, the bank is likely to have past worst of the delinquency cycle. Therefore, pressure on NIM from slippages will subside. Bankâ€™s PCR stands strong at ~75% providing additional comfort.
Healthy growth in advances, expansion of distribution network, stringent credit recovery system and flattening yield curve (resulting in treasury gains) are likely to drive robust growth in non-interest income going forward. This would offset investments in network expansion thereby keeping the cost/income ratio under check. Strong capitalization, Tier-I ratio of 14.3%, and healthy RoEs imply that bank is adequately capitalized for brisk growth over the next couple of years. Stable NIM, improvement in C/I ratio and lower credit cost are expected to keep reported RoAs at impressive 1.3-1.4%.
At current price, Federal Bank trades at undemanding 1.1x FY15 P/adj.BV. Apart from the absolute positives, the bank ranks higher in most of the quantitative and qualitative parameters in comparison to other mid-sized private banks and PSU Banks. For a 1.3-1.4% RoA delivering bank, we think the current valuation is extremely attractive. A highly probable sharp valuation re-rating would likely offer significant return to investors in the medium term. Upgrade the stock to BUY with a 9-month target price of Rs584, implying 19% upside.
|Y/e 31 Mar (Rs m)||FY12||FY13E||FY14E||FY15E|
|Total operating income||24,858||26,895||31,682||38,288|
|Yoy growth (%)||9.8||8.2||17.8||20.8|
|Operating profit (pre-provisions)||15,065||14,948||17,824||22,074|
|yoy growth (%)||32.3||6.7||15.1||25.4|
|Adj. BVPS (Rs)||321.7||344.8||381.5||432.2|
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