Axis Bank (Outperformer)

Mkt Cap: Rs265.8bn; US$6.64bn Bloomberg code (UTIB IN)

In the midst of the global credit market turmoil, as apprehensions regarding growth and profitability of Financials rein high, negative news is often blown out of size. Like other Indian Banks, Axis Bank has been caught in the quagmire of varied market concerns (though valid in concept but their impact is highly exaggerated):

(1) Contingent legal claims as banks’ clients contest forex derivative contracts sold to them, having suffered outsized MTM losses (2) Spillover impact causing a slowdown in fee income from derivative business (3) Prolonged downturn in equity markets hurting distribution fees from insurance, and thereby fee income estimates (4) Trading gains are a high proportion of the bank’s PBT (5) Loan loss coverage is low relative to peers, exposing the bank’s earnings to volatility (6) Expansion in NIMs is largely aided by capitalization.

We have analyzed each of these issues and believe that their cumulative impact is of no material consequence to our PAT projection of 28% CAGR over FY08-10E:

· Worst case hit on account of Forex derivatives is 4-5% on the bank’s PBT (actual hit would be a fraction)

· 1-2% worst case impact on PBT due to closure of derivative business, given the bank’s limited exposure

· Slowdown in third party distribution fees (no visible signs in Q4FY08) to affect only ~8% of fee income; estimates already factor in a slower growth

· Trading gains to PBT is not high at 28% for Q3FY08, but actually ~12% (excluding fees from clients and effect of provisions in excess of RBI norms)

· Loan loss coverage for FY07 is high at ~76% and not optically low at ~37%, due to the bank’s aggressive write-offs (~40% of gross NPAs)

· NIMs improve by 50bps to 3.43% in Q3FY08 over Q4FY07, after adjusting 25-30bps benefit of capitalization.

We are convinced that Axis Bank is amongst the best play (least risk-high growth) in the sector. In the last three months, Axis Bank has been hammered by 21% (Sensex down 19%), currently trading at 2.7x FY09E adjusted book, offering an attractive entry point. While the bank’s near-term ROE is depressed at ~15% due to recent capital issuances, ROA is the relevant profitability metric, which is estimated to improve from ~1% in FY07 to 1.2% over FY08-10E. As the bank leverages the capital raised, the ROE would improve from current levels. We have valued the bank on a sustainable ROE of ~20%, and our CAP model price target is Rs1299. Reiterate Outperformer.

Valuation metrics
Year to 31 March	2005	2006	2007	2008E	2009E	2010E
Net profit (Rs mn)	3,346	4,851	6,590	10,351	13,266	17,027
yoy growth (%)	20.2	45.0	35.9	57.1	28.2	28.3
Shares in issue (mn)	274	279	282	357	357	357
EPS (Rs)	13.2	17.6	23.5	32.4	37.2	47.8
EPS growth (%)	9.8	32.6	34.0	37.9	14.7	28.3
PE (x)	56.4	42.6	31.8	23.0	20.1	15.6
Book value (Rs/share)	88.0	103.1	120.5	245.9	276.5	315.8
Adj. Book value (Rs/share)	83.3	99.2	115.5	243.8	277.4	320.3
P/ Adj. Book (x)	9.0	7.5	6.5	3.1	2.7	2.3
ROAE (%)	18.9	18.4	21.0	17.0	14.2	16.1