Federal Bank - Transitioning away from typical regional bank profile - ICICI Securities

Federal Bank's earnings volatility and sub-1% RoA profile has disconcerted investors - leading to valuation discount and underperformance. However, through the turbulent journey in the past cycle, its structural transition away from 'typical old generation regional bank mindset' is comforting. Why do we say so - 1) revamped business architecture, state-of-the-art digital initiatives, consistent rise in market share; 2) similar to new private bank's approach to build better rated corporate book (78% rated A & above), tread cautiously in SME and channelize retail to existing clientele; 3) strengthened liability muscle - core NR base, tapping HNIs, leveraging digital platform and fin-tech tie-ups. What gives confidence on improving return profile: 1) limited exposure to vulnerable sectors - can manage Covid disruption with worst case credit cost estimate of 2.7%; 2) opportunistically venturing into RoA-accretive segments (CV, PL/CC, MFI, etc), 3) better margin profile coupled with operating leverage benefit. Undoubtedly, fee income scale up is awaited. Valuations at 0.7x FY22E more than adequately captures pessimism and risk-reward is favorable. Reiterate BUY (more convincingly) with revised target price of Rs70 (earlier Rs65).

- Structural transition away from 'typical old generation regional bank mindset': It revamped its business architecture: created separate business verticals, rolled out RM model in wholesale banking to capture end-to-end customer needs, integrated offering along the supply chain, 360-degree servicing points for retail network, navigated outside Kerala (network-2) - demonstrating encouraging results in most of these initiatives reflected in consistent rise in market segment across segments.

- Granular liability franchise is so far under-appreciated: Retail deposits at >90%, cost of deposits at 5.4%, incremental peak FD rates closer to best-in-class and savings deposit rates at the lowest end at 2.5% - but still gaining deposit market share talks of its deposits franchise. Leveraging the brand and inherent geographical advantage, it has built granular deposit franchise focused on sticky non-resident base (~38% of total deposits). Incrementally it is deepening its presence with HNIs (currently forming 45% of CASA), actively chasing high value savings and at the same time targeting millennials through fin-tech tie-ups.

- Asset mix - favorable in current cycle: Competitive deposit profile has helped it build better rated assets, following new private bank's approach in scaling up the balance sheet - build better rated corporate book (78% rated A & above), tread cautiously in SME (mere 6% CAGR over FY18-20) and rising pie of retail skewed towards secured segments (mortgage contributes ~67% to total retail assets) and that too towards existing clientele. This coupled with lower exposure to vulnerable industries (at 5%) will help it navigate better through the crisis.

- How effectively will it navigate current crisis - Besides above stated qualitative factors imbibing confidence, moratorium at ~24% (12th July'20) and ~11/12% adjusted for partial payments, is not unduly out of sync with similar profile banks. Even in the worst-case scenario building estimates for credit cost (at 2.7%), NIMs (30bps lower), fee income (20bps lower), the argument of networth erosion is not sustainable. In such circumstances, 0.7x FY22E BV seems factoring in lot of pessimism rending risk reward favorable. We, now more convincingly, reiterate our BUY.

Shares of FEDERAL BANK LTD. was last trading in BSE at Rs.54.6 as compared to the previous close of Rs. 54.9. The total number of shares traded during the day was 1413818 in over 2382 trades.

The stock hit an intraday high of Rs. 54.8 and intraday low of 53.9. The net turnover during the day was Rs. 76988522.

Source : Equity Bulls

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