>KOTAK MAHINDRA BANK LIMITED (KR CHOKSEY)

Steadying ship in turbulent seas

Impressive Outperformance – Kotak Mahindra Bank beat estimates with Net Profits increasing 40.7% q-o-q to Rs 171 crores on back of continued robustness in the core business. Profits growth from banking activity was even more impressive growing ~44% to Rs 102.6 crores in Q4FY09 from Rs 71.1 crore while profits from lending business (Kotak Mahindra Prime) grew 41% to Rs 47 crores. Capital Markets related businesses underperformed in Q4 with advisory business loosing Rs 3.8 crores on account of slowdown in corporate activity. Brokerage net revenues also degrew ~80% y-o-y as stock market volumes declined. The quality of earnings improved in FY09 as the share of profits from volatile capital markets business declined to 18% and the share of profits from banking and financing business grew to 67%. Management’s ability to manage balance sheet continues to be impressive as the bank was a net lender on most days during the liquidity crisis of
October 2008.

Net Interest Margins – The banks NIMs are easily the best in the industry. NIMs grew 40 bps y-o-y to 6% for FY09 from 5.6% in FY08. Wholesale funding was available at ~6% as the rates on the short end of the curve have been driven down by surplus liquidity while retail deposits, which compete with administered rates, were 150 – 175 bps more expensive at 7.5 to 7.75%. Management believed that it was prudent to boost margins by incrementally shifting funding sources to wholesale deposits from retail deposits.

Asset Quality – Management continued to be cautious during the turbulent times changing asset mix and slowing advances growth. Total retail advances were flat in FY09 at ~Rs 19600 crores. The compositions of retail advances shifted to lower risk secured assets, such as housing loans (which increased 300 bps y-o-y) and away from higher risk assets, such as unsecured personal and business loans (which decreased 400 bps y-o-y) and commercial vehicles (which decreased 200 bps). Gross NPA increased from 2.56% in FY08 to 3.64% in FY09 while Net NPA increased to 2.02% in FY09 from 1.65% in FY08. Coverage ratio declined 4% q-o-q on account of higher slippages.

Our View – At current price of Rs 619 the stock is trading at ~2.72 x FY10E P/BV. We maintain a hold on Kotak Mahindra Bank with a target price of Rs 695, giving an upside potential of 12% from the current levels, on account of: 1) balance sheet well positioned to grow advances by 10 – 15% without pressuring RoE or raising additional capital; 2) incremental shift in asset mix in favor of corporate advances will reduce risk; 3) potential multiple expansion of insurance subsidiary on account of policy changes; 4) rationalizing of bank branches will reduce operating expenses. 5) cost control measures (consolidating back office to lower rental premises and moving front office function to BKC) will improve operating efficiencies; 6) capital markets business well positioned fore recovery. Downside risks to out price target include: 1) volatility in the wholesale funding markets driving up funding costs and pressure margins; 2) slower than expected credit growth; 3) prolonged slowdown in capital markets and corporate activity driving down subsidiary profits


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