IndusInd Bank: Performing under pressure - Buy

Weak credit offtake, increase in bad loans and margin pressure in a downward interest rate cycle have impacted earnings of most banks and also their stock performance in 2015. With the economy not out of the woods yet, the year ahead is likely to present similar challenges.

While the banking space faces challenges, it also offers an opportunity for investors to ride the economic recovery. Rather than buying stocks with beaten down valuations, investors should bet on those with strong fundamentals and resilient performance. This will help weather rough times as well as ride the revival when it happens. IndusInd Bank has delivered steady earnings growth in the last year, backed by strong loan growth and improving margins. At the current price, the stock trades at 2.8 times its one-year forward book, a tad higher than its five-year historical average of 2.5 times. Still, it offers a good buying opportunity for investors with a two to three-year horizon.

One, given the market’s preference for stocks with steady earnings growth, stock prices of most private banks trade at a premium now. For further upside, these banks should continue to deliver strong results that translate into earnings upgrade.

IndusInd traded at over 3.2 times its one-year forward book in the beginning of this year. Strong earnings growth of 27 per cent in the first half of this fiscal saw valuations moderate, even as the stock delivered 15 per cent return. Sound fundamentals and an uptick in the commercial vehicles (CV) cycle should sustain the bank’s earnings momentum at over 20 per cent in the next two years.

Two, while the bank credit growth languishes at sub-10 per cent levels, IndusInd Bank has managed healthy growth in both its corporate and retail loan portfolios. As of September, the bank’s loans grew 31 per cent year-on-year.

This includes the diamond portfolio acquired from RBS in July. Even excluding this, the loan growth was a healthy 24 per cent, driven by the growing traction in retail loans.

Since 2013-14, IndusInd Bank’s retail loan growth had slowed, owing to sluggish growth in the CV segment, which constitutes more than a third of its retail loans. However, the bank has been seeing uptick in the segment in recent quarters.

From the last December quarter when the year-on-year growth was just 0.7 per cent, the growth in CV loans has risen to 27 per cent in the latest September quarter.

Continued traction here should boost growth in the retail segment. Corporate loans grew a healthy 36 per cent year-on-year (24 per cent excluding the RBS portfolio). Three, IndusInd has been able to improve margins in a declining rate scenario. In the September quarter, the bank’s net interest margin improved 20 basis points sequentially, primarily on account of capital raised during the quarter.

The yield on loans fell by about 40 basis points sequentially, which the management attributed to the lower yields on the medium and heavy commercial vehicles segment.

This was offset by a similar fall in the cost of deposits. With effect from May 2015, for deposits up to ₹1 lakh, IndusInd Bank cut its savings account deposit rate by 0.5 percentage points to 4 per cent. This should aid margins in future.

Lastly, the bank has contained slippages well. Its total gross non-performing assets (GNPA) stood at 0.77 per cent of loans as of September 2015, down from 0.79 per cent in the June quarter.