IndusInd Bank: Noteworthy performance - Buy

The fortunes of the banking sector are linked to the overall state of the economy. While there are visible green shoots in the economy, a broad-based recovery within the banking sector is unlikely in the near term.

The rising bad loans of public sector banks and slippages from existing restructured accounts have made it difficult to assess whether the asset quality problem has indeed bottomed out for the sector. But a few banks have continued to grow their loans at a healthy pace, while keeping bad loans under check.

IndusInd Bank has been consistently delivering healthy growth in earnings, thanks to the strong traction in loans and deposits and stable asset quality.

The bank has maintained 25-30 per cent growth in profit in the last couple of quarters which, given the overall weak performance in the sector and record losses being posted by most public sector banks, is noteworthy.

The predictability in the bank’s earnings and lack of good opportunities in the space have however pushed up the valuation of IndusInd Bank in the last one year.

The stock currently trades at about three times its one-year forward book against its five-year historical average of about 2.5 times. But IndusInd remains among the top performing banks, the strong performance in the latest June quarter reinforcing this.

Strong deposit mobilisation, growth in loans and low delinquency rate should keep its earnings growth in the 25-30 per cent range over the next two years. Strong profitability ratios — return on asset at around 1.9 per cent and return on equity in the 16-18 per cent range — present a case for the stock to re-rate higher. Investors with a two to three year horizon can buy the stock at current levels.

At a time when credit growth at the sector level is struggling to move past the 8-9 per cent levels, IndusInd has been able to grow its loan book by 25-30 per cent over the last couple of quarters. This growth has been led by both the corporate and retail segments.

The downturn in the CV segment that had impacted the bank’s retail loan growth about two years back, reversed last year. This was thanks to volume pick up in the CV segment in 2015-16 — heavy commercial vehicles in particular have seen a strong 30 per cent volume growth.

The momentum in volumes is likely to continue, given the possible recovery in the economy. This in turn should aid the bank’s growth. In the June quarter, credit growth in the CV segment was a healthy 21 per cent year-on-year.

Corporate loans continue to grow at a healthy pace, rising 30 per cent year-on-year in the June quarter, driven by 33 per cent growth in SME loans.

The other key issue plaguing the sector is weak deposit growth. But banks that have been able to grow their deposits; low cost CASA (current account and savings account) deposits have particularly been able to manage margins better in the last one to two years.

IndusInd Bank’s deposit growth has been steady in the last five years, clocking an annual growth rate of 22 per cent. Within deposits, the bank has been growing its CASA base at a faster pace — 28 per cent annually. It has been able to keep the momentum going in recent times as well.

While the bank’s yield on advances has fallen by about 70 basis points over the previous year, a similar fall in cost of funds has kept its margins in good stead.

In fact, the bank’s net interest margin improved by about 30 basis points year-on-year to 3.97 per cent in the June 2016 quarter, one of the highest in the industry.

IndusInd Bank has also not faced pressure on account of the RBI’s asset quality review that has taken a toll on most banks’ earnings.

While the gross non-performing assets (GNPA) has inched up marginally from 0.87 per cent of loans in the March quarter to 0.91 per cent in the June quarter, it is still far lower than that of most banks.