Fresh investments with a three-year horizon can be considered in the stock of Axis Bank, our preferred pick in the banking space. The Axis Bank stock is trading at a valuation close to its 2009 lows due to the challenges facing the banking sector.

But prospects for the bank continue to remain attractive, thanks to its strong operating metrics, diversified fee income, strong position as a debt arranger and good risk management.

This makes the current price of Rs 852 a good entry point for the stock. The stock trades at 1.37 times its estimated FY13 adjusted book value. The price-to-earnings multiple on FY13 earnings works out to 7.4. The bank may comfortably match expectations on earnings growth over the next few years. On operations, aggressive branch expansion is helping Axis Bank reduce dependence on wholesale deposits. Superior profitability (return on assets in excess of 1.5 per cent) and high proportion of low-cost deposits are the other key positives.

The net interest margin of the bank after falling to 3.28 per cent in June has improved to 3.78 per cent by September. While the margins may see slight moderation, the bank may maintain it around 3.5 per cent.

Axis Bank has expanded its branches by a third in the last eighteen months. This has allowed it to maintain its low-cost deposit proportion at 42 per cent and reduce high-cost wholesale deposits. Unlike other new private peers, the bank relies more on corporate lending. But though the corporate sector is bearing the brunt of high interest costs, Axis Bank managed to maintain its gross non-performing asset ratio at 1.08 per cent. If one includes the restructured assets, the overall stressed asset portfolio is low at 2.57 per cent of the loan book. Axis Bank has relatively new exposure to the power sector which may be at risk. For the half year ended September 2011, Axis Bank clocked a net profit growth of 26 per cent, aided by a 37 per cent growth in fee income and 19 per cent growth in net interest income. The capital adequacy ratio of the bank is at a borderline 12.2 per cent.

While there is headroom to raise Tier-2 capital, the bank may have to raise fresh equity in FY13. If the Government divests its holding in Axis Bank, the public float will increase and institutional appetite for a fresh issue may come down. This may be partly a reason for underperformance of the stock over the last one month.

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