Federal Bank Ltd - Initiating Coverage, CMP Rs.122, BUY, Target Rs.156 - Sushil Finance

STRENGTH: Healthy Business Growth, Consistent NIM's, Better Asset-Liability Management, Low-Cost NRI Deposits, Stable Asset Quality WEAKNESS: Regional Concentration, Higher C/I Ratio OPPORTUNITIES: Growing Business Prospects Outside Kerala THREAT: Interest Rate Volatility, Prolonged Economic Slowdown may led to Higher Slippages, Slowdown in Gold Loan Disbursements.

Credit Growth to Resume; Expect Loan Growth CAGR of ~19% over FY14-17E

Strong regional positioning, aggressive branch expansion coupled with greater emphasis on strategic segments had resulted in higher than industry growth for FB over FY10-13. Conscious management decision to lower credit off-take due to precarious economic conditions resulted in flattish growth in FY14 wherein corporate book de-grew by ~27% offsetting the growth in SME segment. However, management expects growth trajectory to be on track from FY15 considering the improving economic scenario & healthy pipeline in corporate segment. Moreover, it expects strong growth momentum to continue in SME segment along with revival in gold portfolio which de-grew in FY14, thus fueling loan growth going forward.

Improving CASA along with Higher Focus on Fee Income Generation to result in better PPP Growth

Aggressive branch expansion (2x in 5 years) along with focused strategy to increase share of low-cost deposits has led to remarkable improvement (400 bps) in CASA over the last 1 year to 31%. Relatively lower Fee Income/ Total Income ratio compared to other private banks has been the area of concern for FB for some time now. In order to improvise, the management has taken various initiatives like improving brand visibility, technology up-gradations, focus on cross selling of products etc. Higher CASA, better core-fee income growth coupled with likely break-even of many branches is likely to improve C/I which in turn would result in strong growth in adjusted PPP which is expected to grow at a CAGR of ~19% over FY14-17E.

Improving Asset Quality & Return Ratios to Drive Valuations

Conscious management decision to focus on quality growth by lowering incremental credit to corporate segment has led to improvement in slippages from that segment (from 1.1% to 0.3% YoY) whereas asset quality in Agri/SME/Retail has remained stable over the last couple of quarters. With prudent risk management in place & focus on high quality growth, management expects asset quality to improve going forward. However, conservatively we have assumed higher slippages (1.3-1.5%) & credit cost (~60 bps) for FY15-17E. Moreover with better credit growth, healthy NIMs, improving C/I along with stable asset quality, we expect improvement in ROE & ROA to 14.2% & 1.2% resp. which in turn would drive valuation going forward.

OUTLOOK & VALUATION

Federal Bank seems to be well placed to capitalize on the next leg of growth with major concerns like disappointing fee income, lower cost efficiency & inferior asset quality likely getting addressed by the management through various initiatives. Revival in credit growth (mgmt guidance ~20%) along with stable asset quality would help achieve quality growth going forward. Moreover, improving liability franchise coupled with optimal credit portfolio would offer some room for margin improvement. Hence with focused management approach, we expect gradual revival in key parameters which in turn would help improve return ratios over FY14-17E resulting in likely re-rating of the stock over the next few years. Hence considering the above investment arguments & strong growth prospects, we recommend 'BUY' on the stock with a price target of Rs.156 based on forward P/ABV of 1.5x.

Source : Equity Bulls

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