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Equity Research: Axis Bank Ltd
Axis Bank look strong for an upside potential of 30% from its current market price.
Axis Bank is the third largest private sector bank in India. The Bank offers the entire spectrum of financial services to customer segments covering Large and Mid-Corporates, MSME, Agriculture and Retail Businesses.
The Bank has a large footprint of 4,758 domestic branches (including extension counters) with 10,990 ATMs & 5,972 cash recyclers spread across the country as of 31st March 2022. The Bank has 6 Axis Virtual Centers with over 1,500 Virtual Relationship Managers as of 31st March 2022. The Overseas operations of the Bank are spread over eight international offices with branches in Singapore, Dubai (at DIFC), and Gift City-IBU; representative offices in Dhaka, Dubai, Abu Dhabi, Sharjah and an overseas subsidiary in London, UK. The international offices focus on Corporate Lending, Trade Finance, Syndication, Investment Banking, Liability Businesses, and Private Banking/Wealth Management offerings.
Axis Bank is one of the first new generation private sector banks to have begun operations in 1994. The Bank was promoted in 1993, jointly by Specified Undertaking of Unit Trust of India (SUUTI) (then known as Unit Trust of India), Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), National Insurance Company Ltd., The New India Assurance Company Ltd., The Oriental Insurance Company Ltd., and United India Insurance Company Ltd. The shareholding of Unit Trust of India was subsequently transferred to SUUTI, an entity established in 2003.
Over the past three years, Axis Bank has a) significantly tightened underwriting practices, reduced risk in corporate banking and improved provisioning coverage; b) improved granularity across key metrics – fees, loans, and deposits; c) strengthened digital banking initiatives and expanded its distribution capabilities; d) increased investments in higher margin business (where growth has now accelerated); and e) generated significant value in subs as part of one Axis initiative.
Although Axis has seen a pickup in CASA, retail deposit momentum has been subdued. Apart from lower rates, this has been driven by reclassification of retail term deposits from 'size' based classification to 'ownership' based, and could weigh on retail deposit growth momentum for next 2-3 quarters. That said, the bank has increased investments in payments, wealth management, and corporate salary accounts, and is gaining good traction. This coupled, with an improving macro and rising rates, should help accelerate retail deposits by late F23 onward, in our view.
This should be reflected in higher revenue growth, where we expect an 18% CAGR over F22-F25, vs. 13% over the past three years. We expect margin improvement by 25-30bps, loan growth of 16% CAGR, and moderation in cost to assets to 2.1% by F25. This should drive >20% core PPoP growth over next three years. Coupled with lower credit costs, we expect RoA to improve to 1.5% by F25, from 1.2% currently.
One of the key reasons for the volatile performance of Axis Bank stock over the past decade was weak/volatile asset quality, against lower provisions. This amid weaker than expected macro conditions kept credit cost elevated. The new management team tightened underwriting practices, particularly in corporate/SME banking, and aggressively accelerated provisions in recent years. We expect asset quality challenges to be largely behind now and expect credit cost to be at normalized levels or even below that.
Improvement in granularity over the past five years – across loans, deposits, and fees:
A highlight of Axis Bank's franchise has been increased focus on granularity and hence higher sustainability of its balance sheet and profitability going forward. Over the past 5 years Axis has:
The bank is upgrading its legacy IT systems and building an end-to-end digital stack that is helping new product launches – these include Buy Now Pay Later, multi-currency forex cards, and small-ticket bullet loans. Axis has built a sizable team of 1,000+ for the digital turnaround, and 75% of the new hires are from non-banking backgrounds. It has a 150-member in-house team covering designers, product managers, developers, digital marketers, etc. Consequently, it expects to be nimble, make progress on various digital initiatives, and drive higher operating leverage over the medium term. Subsidiaries' profits have grown at 45% CAGR over past three years, and contribute to 8% of consolidated profits. Axis stock remained under pressure in F22 despite strong asset quality performance. This was owing to weaker-than-expected performance in growth, as opposed to asset quality in previous years. Market share for Axis was broadly stable during F17-F21, but took another leg down in F22. While higher cost played a role, the key driver was lower-than-expected margin progression – both lower loan yields and challenges in retail liability mobilization played a role.
Growth Drivers:
a) Current account deposits: Growth moderated during F19-F21, to a 12% CAGR (daily average basis). This compared to 14% for the system, 18% for HDFC Bank, and 21% for ICICI. In our view, this was driven by moderation in business from certain key government accounts for Axis as well as moderation in growth in the corporate banking/SME segment.
b) Retail term deposits: The trailing three-year CAGR moderated to 13% YoY. Although better than 9% for the system, it was lower than 15% for HDFC Bank and 17% for ICICI Bank. There could be further moderation as well as the bank is reclassifying retail deposits based on 'ownership' as opposed to 'size' based classification earlier.
c) Savings deposits growth held up better than CA/retail term deposits and accelerated in F22: That said, a meaningful part of this was driven by government deposits and we need to see if this will be sustained.
Over the past three years, the bank has been investing to improve its market share in profitable CASA pools including payments, wealth management, and NRI deposit franchise. The bank has also hired external talent to execute these initiatives better. It has also revised key responsibility area (KRAs) of branch managers to help ensure faster deposit growth. Moreover, Axis Bank has been at the forefront of branch expansion, and has increased its presence in semi-urban and rural India as well. Some of these initiatives started to show in strong acceleration in CASA deposits in F22. Axis Bank showed moderation in retail term deposits during F22, as it has been reclassifying deposits based on ownership rather than size. We expect this process to be completed by F23, and expect retail deposit growth to accelerate thereafter. Another driver of strong growth in retail term deposits will be higher rates relative to large private banks and SBI. That said, we expect Axis to be significantly lower on funding costs than the mid-sized private banks, and hence perform better on market share gains relative to them.The loan growth acceleration in recent quarters has been led in particular by relatively higher-margin segments. Historically, we have seen Axis Bank execute well on retail and gain market share on a sustained basis. As the bank achieves growth in granular liabilities, we believe loan market share gains would accelerate. As seen in the exhibits below, Axis's market share relative to HDBK is significantly lower. Further, Axis has also invested in partnerships and increased focus on acquiring customers externally.
It is expected that the loan spreads will improve for Axis. This will be led by mix shift towards higher-yield loans, both from the shift towards retail, as well as higher-margin segments within that (unsecured, rural banking etc). Another very important factor driving this would be higher rates. Over the past two years, the share of floating rate loans (and repo-linked loans within that) has improved sharply. This will help faster repricing of loan assets, and also partly help offset the increased cost of retail term deposits.
d) Moderation in cost ratio: One of the key positives of Axis Bank's strategy is accelerated investments in technology initiatives despite slower growth in revenues during the COVID crisis. While it weighed on core PPOP growth, and hence profitability, the bank has narrowed the gap on technology-related investments relative to peer strong banks over the past two years. Axis has still guided to elevated ratios of costs to assets in the near term – however, this will come with unchanged profitability, and implies that management intends to capitalize on the benign credit cycle – rather than pass lower credit cost to the bottom line. We believe this strategy will be implemented by some other strong banks as well in India.
e) Narrowing PSL deficit given increased focus on rural banking: Another big challenge for Axis during F19-F20 was a sharp rise in RIDF-related investments. These are low-yielding investments that banks have to make if they are unable to meet the priority sector lending targets via an organic route. The new Axis management team has accelerated organic lending to PSL-compliant loan portfolios, and over the past few years, the deficit has narrowed. That said, the investments in PSL- related low-yielding investments are still high (given history) and will take three years to moderate/fall in line with peer banks. As this plays out, we expect margins to benefit 5- 10bps over a three-year period.
f) Steady growth in fee income:
Axis Bank is well placed on fee income growth. The bank has moved to an open architecture and continued under-penetration implies strong growth, particularly should COVID-related challenges subside in F23. Even on cards, the bank has increased its focus on retail spending and increased partnerships with large players for co-branded cards. Further, it is expected that the revolve ratio to improve over the next two years, driving further improvement in fee income pools and helping fee income grow broadly in line with loan growth. Over the next three years, It is expected that the loan growth to accelerate (~16% CAGR during F22- F25) and margins to improve 20-25bps – by our estimate, this will drive ~15-18% NII growth over the next three years. Cost to assets ratio will remain elevated in F23, as the bank continues to invest – this is to take advantage of lower credit costs. We expect cost to assets to moderate to 2% by F25.
Axis has proposed the acquisition of Citibank's Indian consumer businesses, subject to regulatory and other approvals. We believe this is a step in the right direction, and if executed well, it would drive higher sustainable RoE at Axis over the medium term. The acquisition should help Axis improve its market share in high-margin retail businesses (CASA, credit cards, wealth management, etc.), improve granularity, and increase its presence in the affluent/corporate salary banking segment. Citibank's retail franchise includes a loan book of Rs274bn (36%, 32%, and 31% in mortgages, cards, and other retail loans, respectively); deposits of Rs502bn (of which 81% are in CASA); wealth management AUM of Rs1.1trn; and other retail operations. On a pro forma basis, this implies increases of 4% in loan book, 7% in deposit base, and 42% in wealth management AUM for Axis Bank. Axis will get access to 3mn unique customers, which includes >1mn salaried customers of 1,600+ corporate relationships. These deal include customer retention, differences in employee pay structure, technology migration, and customer consent for transition from Citibank to Axis. Axis notes that it has a rich assortment of Citibank alumni heading its credit cards, SME, Bharat Banking, and wealth management businesses. This will help further during the transition. Further, Axis mentioned that there are price adjustment mechanisms in place, in case Citibank's business metrics were to show significant deterioration.
Historical Financials:
Estimated Financials:
Conclusion:
We forecast 1.4% RoA by F25 and see upside risk. At 10-11x leverage, this implies 15% RoE. This compares to RoE of 7% in F21 and 12% in F22. We believe this would be much more sustainable than it has been historically. The balance sheet is much stronger and more granular than the past. We believe a P/BV multiple of ~1.65x is fair against the above backdrop. We expect 30% upside in the stock over the next 12 months.
I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Stocx Research Club). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI Registered individual/entity and the above research article is only for educational purpose and is never intended as trading/investment advice.
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