Axis Bank

Axis Bank posted another quarter and year of impressive numbers. March 2010 was the 22nd quarter in a row when the bank posted net profit growth in excess of 30 %. During the year, net profit went up by 39 %, while the net interest income was up 36 %, showing growth of 47 % in 5-year CAGR.

Similarly, the fee income for the bank grew by 51 % CAGR over the five years ending FY 10. The bank continues to maintain good asset quality with net NPA at 0.36 % compared to 0.75 at the end of FY06. During the fourth quarter, advances for the bank grew by a healthy 28 % over the previous year, against the industry's growth of just about 18 %. The cost of funds also declined to 4.54 % against 6.64 % in Q4FY11, which led to improved net interest margins of 4.09 %.

On 12-month trailing earnings, the stock is trading at 18.78 times. Given that it is consistently growing at over 30 %, the stock does not look too expensive.

Why buy Axis Bank: High business growth, low cost of funds, expanding NIM, improving asset quality.

Parameters to identify healthy Banking stocks

It's very difficult to understand the Banking business thoroughly. However, to find some safer banking stocks one should look at the parameters given below.

1) Core business: The core business of a bank is to lend, so it's important to see how the advances have grown in the past, at least in the last few quarters. Looking at the growth in the interest income will also give you a fair idea. But, remember, this is only a necessary but not a sufficient condition. As there is a possibility that to gain market share the bank might be ignoring the quality of lending.

2) Crests And Troughs:

Although banking stocks fell along with the overall market as global crisis intensified, it has rebounded sharply and outpaced the overall market on prospects of economic recovery.

3) Asset quality: In banking, asset quality is of prime importance and looking only at profitability is not enough. Profits is not the right criterion to look for a good bank; one should rather look at the balance sheet. For e.g. Vijaya Bank. For FY10, it reported a profit of Rs 502 Cr, or Rs 240 Cr higher than the previous year's profit of Rs 262 Cr. Thus, its profit almost grew by 92 %. But, at the same time, its net NPA also grew by Rs 289 Cr.

The Bank should reduce net profit by increase in net NPA to get the real profit figure because the bank is not sure whether it will recover NPAs. Also, from September 2010, banks will have to provide for 70 % of gross NPA, which will dent profits significantly for banks not making sufficient provisioning at this stage.

4) Net interest margin (NIM):It is a measure of the bank's profitability, and is calculated as net interest income (interest income minus interest expenses) divided by interest yielding assets. This checks the bank's ability to price loans at higher rates, which is also function of bank's ability to mobilise low cost deposits -- current account and saving account (CASA). The higher the CASA ratio, the better it is. Also, as we are moving into higher rate scenario, CASA will become even more important. Since as interest rates go up, the banks with the highest CASA account will perform the best.

5) Other income: There are two big components of other income: fee income and treasury income. Although growth in fee income can be predicted somewhat, treasury income is relatively volatile. It depends on the wider interest rates situation in the economy, and is also affected by various factors like the monetary policy and government borrowing. As banks in India are required to keep 25 % of their demand and time liability in government securities, the overall effects of bond price movement can only be managed a little.

6) The road ahead:

Unanimous projections: The fiscal year 2010 wasn't too good for the banking industry in terms of loan disbursal. It remained subdued for most of this period, even as growth in credit fell to single digits at the end of October 2009. But later, as economic activity picked up, credit growth accelerated to around 17 % at the end of the financial year. Analysts expect it to remain robust. The offtake is once again expected to come from the infrastructure space, which, after a lull, has started witnessing higher activity.

Banks have raised capital in the previous year. Further, the government's decision to infuse capital into some banks would increase their limit for infrastructure lending.
7) Treasury Tricks: When the RBI followed the policy of lower interest rates to bring growth on track, the yield on government bonds came down. As a result, banks made huge profits on bond portfolios.

However, that trend has reversed now. The yields have risen significantly, with impacts already visible on banks' result for the March 2009 quarter. Most banks have suffered losses on bond portfolios.

Analysts believe that in the coming quarters, too, the bond yield will remain high and it would be difficult for banks to show treasury gains. But yields are not expected to harden too much from here on.

Economists expect yields on 10-year government paper to move at most to 8.5 % from the current 7.8 %. So, major negative surprises can be ruled out. Also if the government raises the FII limit in G-secs, as reported by the financial media, greater demand will raise their prices, thereby restricting the rise in yield.

8) Maintaining Margins: The net interest margin rose in FY10. One of the causes behind this rise was the high proportion of low-cost CASA deposits in the overall deposit base. As rates on term deposits were low, it became less attractive, and the share of CASA increased.

However, as term deposit rates have started to rise again, banks will face difficulty in maintaining the CASA level, even as pressure might be compounded by the lag that exists in adjustment of lending and deposits rates. The previous interest rate cycle was testimony to the hypothesis that lending rates, particularly in the case of Indian banks, react with a two or three quarter lag, compared to deposit rates. We expect this lag, coupled with an increase in savings rates, to exert pressure on margins in FY11.

Indian Banking Industry - View

The Indian banking industry, unlike its peers in the West, came out relatively unhurt from the global financial crisis. The stocks, however, did correct a bit on the concerns of rising non-performing assets (NPAs) and loan restructuring.

But, with the fear subsiding and the economy getting back to the higher growth path, there is renewed interest in the sector. The reasoning behind this is, if India has to grow at over 8-9 %, companies will need funds for expansion. In the absence of a vibrant bond market, they will have to tap banking sources for funding their needs. Also there is a huge need of Housing & Infrastructure development.   

Therefore, investors are looking at this sector as a proxy to the India growth story. So, if you are also eyeing gains from the India growth story through the banking sector, we tell you how to look at stocks in the banking sector, and profile five banks we like at this stage.

IT sector to see a better year ahead

The Indian Information Technology services sector has done well in the quarter ended March 31, with year-on-year revenue and profit growth for the top seven firms distinctly better than in the previous three quarters.

However, small and mid-size firms have disappointed, with flat revenue and a modest 13 % rise in net profit.

Growth in revenue remains single-digit for all four quarters, suggesting muted pricing power, no escalation in clients' budgets and appreciation of the rupee by six % in the past year and 1.5 % during the fourth quarter.

The net profit rose more than 20 %, as companies benefited from revenue hedging on account of the strong rupee.

Improvement ahead:

The net additions in clients remained subdued, with numbers for the top seven companies up by only 6 in the past year, and thanks only to a net addition of 23 in the fourth quarter.

However, the outlook seems to be changing. There has been quarterly addition of over 140 new clients in each of the past three quarters. Two, there has been net hiring of 27,641 employees in the fourth quarter, with a proposed addition of around 1,00,000 more in 2010-11.

The increase in revenue predicted by Cognizant for calendar year 2010 from 20 % to 25 % and the discussion it has initiated on a price hike with its clients also suggest an improving environment ahead.

The net margins of large and small-midcap companies have seen steady improvement from 17.3 % eight quarters earlier to 21.6 % in the quarter under review, due to increase in volume growth and cost control.

The total expenditure to sales ratio declined consistently from 81.4 % in the quarter ended June 2008 to 79.4 % during the quarter ended March 2009 and 76.6 % now.

The ratio of cost of employees to sales has been more or less steady, around 44 % in the past eight quarters, despite a net addition of about 1,44,000 employees by the top seven companies.

Infosys Technologies and Tata Consultancy Services (TCS) had built strong bench strength (staff without project work) during the slowdown, to utilise during an expected expansion in projects.

This helped Infosys and TCS to deliver volume growth without adding cost. HCL Tech and Wipro were affected more by increased attrition and wage inflation than Infosys and TCS.

The year-on-year net margins of TCS improved by 470 basis points to 25.85 %, as the company's total cost to sales ratio declined over 455 basis points over the same quarter last year.

TCS added around 19,000 employees last year, but the ratio of cost of employees to sales fell from 37.4 % a year earlier to 35 %, indicating higher utilisation.

Hedging pluses:

Going forward, Indian IT services companies are likely to benefit from the hedging of export revenue at Rs 46-50 a dollar, with the rupee now averaging at Rs 44.50. Infosys has a hedge position at the end of the quarter at $525 million.

The company has forward contracts of $267 million, Euro 22 million, 11 million pound and $3 million, plus options' contracts of $200 million. The management hedges two quarters' net exposure.

Infosys margins would be impacted by rupee appreciation by three % if the revenue productivity is assumed to be flat. The impact of this year's pay hike would be 300 basis points.

TCS expects to maintain margins at current levels at a rupee/dollar rate of 46. The rupee appreciation would have an impact on margins. Wipro's gross hedge is $1.7 billion, at Rs 40-50 a dollar.

It expects to face margin pressure and lower growth in revenue if the rupee appreciates more than an average of 45.60.

Polaris has a hedge of $100 million at Rs 48.28 and expects 30-33 % growth in earnings on the back of a growing size in product deals. Tech Mahindra has forward hedges of close to $670 million at Rs 46.7 and 270 million pound at $1.78/pound.

Sensex @ 20k by end-2010

One of the noted analysts, Dipan Shah said about the future prospects of Indian markets. He expects the global, and consequently, the Indian markets to remain volatile at least in the near-term. There is uncertainty over the recovery in developed economies like Europe.

On the other hand, China's measures to curb the growth rate and potential asset bubbles also lend uncertainty to the global economic scenario. On the domestic side, we have to get more comfort on monsoons and on inflation/interest rates.

With more clarity on the above-mentioned factors and on FY11 earnings, we expect markets (Sensex) to steadily move up to 19,000-20,000 levels by December 2010.

The triggers for the markets to move up from the current levels are a good monsoon and stability in the global economy. These factors will likely lead to increased fund flows into the markets.

The future of Indian stock market is heavily dependent on the following three parameters:

*Future growth of the Indian economy, annual inflation, and productivity related improvements;

*The inflow and outflow of foreign institutional investment;

*Any movement of price-earnings ratios.

 

Alok Aggarwal, another analyst says that the Indian stock market, which was grossly overvalued two years ago, is now more reasonably valued, thanks to India's continued economic growth.

According to him, three groups of industry verticals which together dictate the Indian stock markets will be responsible for this growth.

Group 1: Retail, travel and hospitality (e.g., airlines, hotels, theme parks), financial services, healthcare (including medical tourism, alternative medicinal centers and spas, hospitals, pharmacies, and laboratories), entertainment (including the Indian movie and TV industries), and private education.

This group is expected to grow at an annual rate of 21-22% per year.

 

Group 2: Hi-tech services and products like information technology and application development, business process outsourcing, knowledge process outsourcing, drug research and clinical research outsourcing, engineering services outsourcing, software and solutions related to the consumer Internet, software as a service, open source, software-cum-services, and telecommunications (both wireless and wire-line).

This group is expected to grow at an annual rate of 17-18% annually.

 

Group 3: Automobiles, automotive components, electrical and electronic components, specialty chemicals, pharmaceuticals, gems and jewelry, textiles, and sectors related to construction, real estate, and infrastructure.

This group is also expected to grow at an annual rate of 17-18% per year.