Karur Vysya Bank: Buy

With the economy at the cusp of a recovery and the Reserve Bank of India signalling a rate cut as early as the beginning of next year, the banking sector is likely to witness better earnings growth ahead.

Within the sector, a recovery augurs well for mid-size banks such as Karur Vysya Bank (KVB). The bank is likely to scale up its loan growth at a fast clip, given its focus on the SME (small and medium enterprises) and retail segments.

A key player in South India, KVB’s recent capital infusion of ₹625 crore, through qualified institutional placement, will help fund its next leg of growth.

After facing asset quality pressures over the last couple of quarters, the bank’s conscious decision to cut down exposure to stressed sectors should ease troubles and improve earnings.

At 1.3 times its one-year forward adjusted book value (a tad lower than its five-year average of 1.4 times), KVB is attractively valued and offers a good buying opportunity for investors with a two- to three-year time horizon.

Better traction in credit growth, stable net interest margin and improving asset quality are expected to drive earnings growth of 25-30 per cent over the next two years.

KVB has been able to grow its loan book at a robust 26.5 per cent annually between 2008-09 and 2013-14.

However, till 2011-12, the bank’s portfolio was tilted towards the corporate segment, which comprised about 42 per cent of total loans.

Taking stock of the risks, the bank has been reducing its exposure to the corporate segment; the segment now constitutes 37 per cent of the loan book. Instead, the bank has upped its exposure to the SME and retail segments.

Retail, which was about 8 per cent of the bank’s loan book till about two years back, is now 13 per cent of its loan portfolio. About 69 per cent of the bank’s corporate loans are less than ₹100 crore in size, indicative of the banks’ focus on small ticket loans.

The bank has also reduced its exposure to stressed sectors. Infrastructure, which was about 12 per cent of the bank’s loan book in 2011-12, is down to 9 per cent. Within this, the ailing power sector is now 4 per cent of the bank’s loans — down from 7 per cent two years back.

Consolidation of its portfolio in the light of growing risks has slowed down its loan growth, from 23 per cent in 2012-13 to 15 per cent in 2013-14. As of September, KVB’s loan growth was a modest 11 per cent year-on-year, due to subdued growth in the corporate segment as well as decline in its gold loan portfolio which is a little over a fifth of the loan book.

The loan book is expected to grow better in the coming years, driven by the retail and SME segments. Recovery in the corporate segment will be an additional boost. Loan growth should be 18-20 per cent annually over the next two years.

Better traction in credit growth will help improve the bank’s earnings, which took a 22 per cent knock in 2013-14. Lower growth in net interest income, coupled with escalating costs on branch expansion, impacted the bank’s earnings.

The bank doubled its branch strength since 2009, and the cost-to-income ratio shot up from 42 per cent in 2011-12 to about 54 per cent in September 2014. The bank has now slowed down its branch expansion spree, adding about 37 branches in the last one year, down from 100 in 2012-13. This should help bring down its costs. In the first half of 2014-15, the bank’s net profit grew by about 4.6 per cent year-on-year. Its net interest margin, which has been under pressure, is likely to improve marginally on the back of lower cost of deposits, given the strong retail deposit base.

Karur Vysya has lower dependence on high cost wholesale deposits and continues to focus on retail deposits for its term deposits as well. The bank’s CASA ratio is a healthy 21.8 per cent as of September.

The bank’s asset quality pressure increased over the last couple of quarters, due to higher slippages from certain accounts. Gross non-performing assets (GNPA) now stand at 1.36 per cent of loans, up from 0.96 per cent in 2012-13.

However, given the bank’s reduced exposure to stressed sectors, slippages are expected to stabilise in the coming quarters.

But restructured assets, which are at 4.5 per cent of loans, are on the high side and need to be watched carefully. Incremental slippages on this front is a risk to our recommendation.

COMMENT NOW