Axis Bank: Buy

M. V. S. Santosh Kumar
Investors with a two-year investment horizon can consider buying the stock of Axis Bank. The bank’s performance has so far allayed fears about an earnings slowdown due to the ongoing global turmoil, high interest rates and liquidity crunch. However, given the highly volatile markets, it is advisable to accumulate the stock in phases.
A large low-cost deposit base, superior net interest margins (NIMs), robust fee income, high quality diversified asset book and aggressive branch expansion are the key positives from a two-three year perspective. The company’s recent wins in litigation relating to derivative exposures, also alleviate concerns on this score.
At the current price of Rs 619, Axis Bank trades at 2.2 times its (September 30) book value and 15 times the estimated FY-09 earnings. (the peak valuation for Axis Bank was 5.5 times book value and 41 times earnings). This places it at a premium to all other private banks, except for HDFC Bank, but is justified by the bank’s low proportion of retail loans and strong earnings growth. Strong loan growth
Axis Bank’s net profits have consistently grown at 60 per cent year-on-year over the past five quarters, amidst challenges such as high interest rates, concerns about derivative exposures, trading losses and so on. In the September 2008 quarter, Axis Bank posted a net profit of Rs 403 crore, a 77 per cent increase Y-oY. The bank has managed a loan growth of 54 per cent and deposit growth of 60 per cent in this period. The growth in advances was driven by SMEs (68 per cent) and retail (55 per cent).
Deposit growth was driven mainly by increase in term deposits (higher by 75 per cent). Yet, the bank has managed to maintain its proportion of low-cost deposits at 40 per cent, in a scenario where there was a scramble for such deposits. Net interest income rose 55 per cent year-on-year. NIMs expand
Despite pressure on cost of funds across the sector, NIMs (3.5 per cent from 3.3 per cent) have improved in the last three months, driven mainly by higher prime lending rates and better cost management.
The fee income also increased 91 per cent, covering almost 90 per cent of operating expenses. The major contributors to the fee-income are debt-syndication, forex treasury, cash management services and third-party distribution, many of which appear sustainable. The slowdown in the trading income pulled down the non-interest income.Capital adequacy declines
Provisions and contingencies increased by 122 per cent, as the bank enhanced NPA provision coverage (52.6 per cent from 42 per cent), and probably due to loss in the investment book. However, Net NPA/advances came down from 0.55 per cent to 0.43 percent.
The only point of concern in the numbers is the sharp deterioration in the capital adequacy ratio, down to 12.1 per cent from 17.59 per cent. This can be explained by strong growth in advances and a possible increase in exposure to assets with higher risk weights. Loan book
Axis Bank’s loan book is focussed mainly on mid/large corporate (49 per cent), retail advances (24 per cent), SME advances (19 per cent) and agriculture advances (8 per cent). Eighty four per cent of the corporate advances and 78 per cent of SME advances are ‘investment grade’, which demonstrates a prudent focus on asset quality.
Asset quality relating to retail advances is not as big a source of concern for Axis Bank as for other private sector peers, given that only a fourth of the retail book is accounted for by personal and credit-card loans.
The bank has a credit-deposit ratio of 67 per cent, below the industry average of 73 per cent, indicating that the bank has been investing excess cash, rather than deploying it to grow advances aggressively in the uncertain environment. Outlook
Axis Bank has maintained its return on equity at 17 per cent and return on assets of 1.25 per cent (both higher than the industry average). While the bank is expected to continue its growth momentum, the quality of assets may deteriorate if interest rates do not decline. The recent 250 basis point cash reserve ratio cut may release Rs 2,500 crore of funds to aid growth. That the bank has managed to add to its deposit base despite its rates being not too competitive, gives it an edge in the current environment.
In the last 12 months, the bank has added 135 branches and 582 ATMs across 90 new towns and cities (opened 16 branches in September quarter); this may help to further attract low-cost deposits and boost fee income.
Favourable Court rulings for Axis Bank in litigation relating to derivative transactions structured for corporates, reduce risk on this count and may allow the bank to write back the contingent provisioning of Rs 70 crore towards these cases.
Apart from an uncertain macro environment and risks relating to asset quality, high FII holdings in the stock will remain a key risk to the stock price. Between March and September this year, FIIs have pared their holdings in the stock from 35 per cent to 27 per cent.