Kotak Mahindra Bank

Fresh investments can be considered in the Kotak Mahindra Bank (KMB) stock. Even as the bank closed 2009-10 with a doubling of its net profits, it is likely to sustain high earnings growth over the medium term due to strong advances growth, high margins and a ramp-up in subsidiary profits, linked to equity markets. Over the medium-term, a loan book growth of 35 per cent appears quite possible for the bank, given a scenario of reviving retail credit and the bank's increased focus on corporate credit.

At the current market price of Rs 760, the stock is trading at 16 times its estimated 2010-11 consolidated earnings. After removing the fair value of subsidiaries (estimated at Rs 342/share), the price to book ratio for KMB stood at 2.85. This represents a discount to private peers such as HDFC Bank and Axis Bank, but is at a premium to ICICI Bank and YES Bank. Valuations are justified by strong loan growth prospects and high margins.

High capital adequacy levels (18.4 per cent), high return on assets (3 per cent), best-in-industry net interest margins (6.3 per cent), high credit-deposit ratio (87 per cent) with increasing subsidiary contribution to the earnings are key positives for the bank. While net interest margins may see some moderation over the next few quarters due to cash reserve ratio hikes, any increase in policy rates may be passed through to the customers, thereby limiting the margin contraction.

KMB's loan book too is tilting towards corporate loans, with the corporate-retail mix moving from 20:80 to 35:65 this year. The current mix (after reducing unsecured lending) augurs well for high margins to be maintained. In terms of funding, the bank has been improving its proportion of core deposits by reducing high-cost borrowings and focussing on retail deposits. The gross NPA ratio stood at a relatively high 3.6 per cent as of March 31, 2010. But increasing provision coverage may help mitigate this. The bank's current coverage of 58 per cent may improve to 70 per cent over the next couple of quarters. The bank has also cut back on unsecured lending and is focussing on secured mortgages and auto loans.

KMB is present across the financial services value chain, with good market shares in broking and investment banking activities. The company also has NBFC arms: Kotak Prime, which disburses auto loans, and Kotak Investments, which disburses loans against shares. For 2009-10, Kotak's subsidiaries chipped in with over 53 per cent of the consolidated profits.

With more household savings expected to come into the equity market, both directly (broking segment) and indirectly (through mutual funds and insurance), Kotak stands to see strong growth in its subsidiary businesses. The investment banking and advisory arms are highly leveraged to the revival in the primary market.

via BL