Q4FY23 Review: Federal Bank: High growth and profitability

8 May 2023 , 10:44 AM

Federal Bank’s (FB) Q4 PPOP was in-line, but lower provisions drove bottom-line beat of 15%. We expect FB to deliver 15% earnings Cagr over FY24-26, and 30bps of higher ROA relative to LT avg. This should be driven by further market-share gains, improved efficiency and rising share of higher-yielding new products. 

Superior execution, macro tailwinds underpinned record-high profitability: 

Federal Bank’s record high ROA of 1.4%/1.25% and ROE of 17%/15% in Q4FY23/FY23 respectively, is a culmination of: (1) Steady market share gain of 30-40 bps in business over last 5-6 years. (2) Favourable rate cycle driving NIM expansion. (3) Rise in the share of recurring core fee income. (4) Low slippages (especially corporate) coupled with good recoveries, leading to credit cost of 0.5% in FY23.

Next leg of growth to ride investment in high-yielding businesses: 

Key levers for RoA expansion would be (1) Consistent growth in business (2) Improve efficiency with light branch and heavy distribution (3) Increase fee income and cross-selling by leveraging data (4) Maintaining asset quality (5) Enhance yields with focus on highyielding segments – share has risen 3pp in last 3 years to 20.7%. With FB’s unsecured loans at only 7% vs 10-16% for larger peers, there is enough headroom to grow. We expect net profit to grow at 15% Cagr over FY24-26.

Valuations undemanding for mid-teen ROEs: 

Analysts of IIFL Capital Services build capital raise of Rs25bn in FY24 (9% dilution) as Tier1 ratio has declined to 13% due to bank’s net capital consumption. As the bank continues to execute on its new businesses, we expect it to deliver avg. ROA of 1.2% over FY24- 26 vs 5yr avg. of 0.9%. Our GGM-based TP of Rs160 (25% upside) is derived using fair FY25 P/B of 1.2x. We recommend BUY as the valuations are undemanding at 1.1x 1YF P/B and 8.0x P/E (both in line with longterm avg.) for mid-teen ROEs.

Analysts of IIFL Capital Services maintain Buy with target price of Rs 160.