Buy Axis Bank on its improving revenue

We maintain our 'buy' rating on Axis Bank with a 12-month price target of R1,400 based on FY14e P/BV of 1.9x. We value Axis Bank on a two-stage residual income model. Assumptions for the model are income CAGR of 16%, dividend payout of 20%, cost of equity at 14.8% (in-house estimate), terminal growth rate of 5% (nominal growth rate for developed countries). However, sharp reduction in its high CASA due to rising term deposit rates and higher slippages pose as key upside risks to our estimates.

Axis Bank reported a steady quarter. Second quarter earnings were largely on expected lines. Margins improved, fee income was strong, and even as reported NPLs and restructured loans increased, they were better than expectations. We expect margins to further improve as wholesale rates have declined. While concerns on asset quality do prevail, our estimates do include it. A better macro environment and certain policy measures give us comfort that NPLs are unlikely to be worse than our estimates — we consider them conservative. Valuation at 1.5x FY14e PBR still looks attractive for a 19% RoE.

Reported NPLs have trended better than expectations, as they rose only by 5% at gross levels and are currently 1.01%; net NPL stands at 0.33%. Slippage during the quarter was at R630 crore (1.5%), which we believe includes a large corporate account. Restructured assets increased by 6% and are currently at 2.4% of loans. While NPLs and restructuring will rise over time, we build fairly conservative estimates.

A bright spot during the quarter was a strong fee income of 20%, mainly driven by retail fee which grew by 43%. Loan growth, however, was relatively weaker at 23% and flat q-o-q due to slower growth in the corporate loan book, particularly slower SME loan growth, even as retail loan growth remained strong at 51%.

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