Monday, March 24, 2014

Axis Bank - High quality, conservative (with blemishes) but there's value here

BSE: 532215|NSE: AXISBANK|ISIN: INE 238A01026

Used to be UTI bank - and probably one of the safest in terms of their gross NPAs. Tier 1 capital ratio is better than even HDFC bank at 12.23% at the end of the last financial year.
I compare all banks to HDFC Bank as in my opinion that is the bank to emulate. Interestingly Axis beats HDFC Bank on the employees front as well. Lets get straight into the details ...

1. How good is the Moat?

Grade B+ moat

  • Customer loyalty: Similar to HDFC. Customers are unlikely to switch to unknown names due to trust issues but among the big 5 or 10 banks competition is fierce.
  • Product: Nothing special. All banks offer similar products.
  • Sales and distribution: This is the core of any retail bank. Axis has 2321 branches and 12328 ATMs as of Dec 2013. Branch network on an annualized basis is expanding at around 25% per year. This network is the most valuable resource after the employees of the bank and is used to distribute third party products (MFs, Bancassurance, etc.) for a fee - I love that kind of income as its fairly risk free.
  • Vendors: For a bank vendors are depositors. Deposit % of total borrowings stands at 85.1% which is excellent but a bit behind HDFC at 88% or so
  • Employees - Profit per employee is 0.15Crores better than HDFC Bank at 0.10Crores or so. Business per employee is 12.15Crores - far better than HDFC Bank at 7.5Crores. This shows in the employee cost being 7.9% of sales versus HDFC Bank at 9.8% of sales. This also shows that the average compensation of a Axis employee is 7.7Lakhs/year verus 6.1 Lakhs/year for HDFC Bank. Axis wins hands down on this one.
  • Performance during recessions - as covered in the article on HDFC Bank the domestic credit to GDP ratio is very low at 51% as per the world bank. So I would not worry too much about the sales growth part. The issue is asset quality where this bank is slightly weaker than HDFC Bank.
  • #1 concern is the proprietary trading profits of 700+Crores - Even though this is positive in FY2013 it could very well be negative. Unless the bank is purely engaging in true arbitrage positions this is a VERY Bad sign. Retail banks should not be allowed to have proprietary trading operations. What slowly happens is that in the bull run years these desks generate money by being levered and being exposed to market beta. Management continues to allow them more and more risk until the big crash takes everything with it. It has been seen time and again on wall Street. This why I am a support in part for bringing back the Glass–Steagall act.
  • Overall B+ moat as asset quality concerns are slightly higher than HDFC Bank and the proprietary trading cowboys!

2. Risks

  • Proprietary trading - This is the #1 source of risk and can take an institution down.
  • Cost cutting to get business - even though the bank is more efficient on the employee front - they are giving out cheaper loans with higher NPAs showing that they are taking higher risk with lower returns. They are also taking money from the market at higher interest rates. Need to improve the NIM.
  • Customer concentration risk - 27% or so of the lending is retail loans which is mostly housing loans. Corporate credit is about 50% of the advances - unfortunately not much detail is given about these loans and their concentration and this worries me a bit.
  • Asset quality risk - gross NPAs for HDFC are at 1% whereas Axis has them at 1.42%.

3. Financials

  • Foreign exchange risk at a sophisticated bank like this seems to be hedged but I am still uneasy because of the prop desks. I have not been able to find how much risk the prop desks are allowed to take.
  • Employee Stock options: I am a supported of ESOPs in small degrees. In large degrees they make the management team take large risks not commensurate with the returns. Annually the bank issues about 0.6% of options. There are options pending for exercise in the money for about 2.4% of the total stock. They use the intrinsic value method with reasonable assumptions on the black scholes model.
  • Margins are hovering between 13% and 15% which is healthy for this bank
  • Dividend % of earnings is healthy as well around 18%
  • Net interest margin is at 3.53% which is much weaker than HDFC Bank at 4.5%
  • Cost of deposits is 5.9% versus HDFC Bank at 5.5%
  • Average interest on advances is 9.7% versus HDFC Bank at 10.8% - this is where Axis is loosing out. Their loans are cheaper than HDFC Bank with a higher NPA %. I am guessing they are using more people to address
  • Advances per branch are around 101 Crores which is marginally higher than HDFC at 97 Crores
  • Well capitalized as per Basel norms. Typically have maintained this and should not be a problem unless of course NPAs go out of control or prop desks go bonkers.

4. Soft factors

  • Promoters are SUUTI, LIC and General insurance company along with 4 others. They have recently offloaded their stake
  • Over 40% was owned by foreign institutional investors at 31st Mar 2013 - now I think it should be over 50% after the stake sale. This should hopefully ensure good corporate governance. Will also cause volatility on the stock.
  • I have been unable to find the director shareholding in the bank.
  • Index % - Axis bank is 1.8% of the SENSEX and 1.5% of the NIFTY. It is also part of several other indices.

5. Pricing

  • Bank is trading at around 11.5 times trailing 12 months (TTM) earnings. If it were to grow earnings at 15% for 6 years and then 10% for 6 years and 5% a year thereafter this price would be a good one to get in. So far this has happened and if the bank is able to capitalize on this position it could be a good long term value investment at 1390 per share or 65,100 crores of market cap.
  • Price to book - Around 2 times book. This should probably be looked at in terms of earnings as the returns on equity fairly robust.
  • On a relative basis the bank is far cheaper than HDFC trading at 21+ times earnings. I agree it should trade at a discount to HDFC due to gross NPAs and prop trading but this difference is a bit too high.

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