Buy Karur Vysya Bank - Centrum

A re-rating candidate

Karur Vysya Bank (KVB) is a play on consistently robust performance driven by strong asset side position - a result of deeper understanding of its target segment. This has translated into strong pricing power and contained credit costs and hence robust avg ROA of ~1.6% for last decade. Renewed focus on improving liability side should aid continuity of impressive return ratios in future. Given robust financial performance on consistent basis, current valuations seem unjustified on absolute (1.1x FY14E PBV) and relative basis (~40% discount to new-gen pvt banks and at par with south based peers). KVB, a regional but quality franchisee, should get re-rated from its currently attractive valuations (1.1x FY14E PBV). Initiating coverage with Buy.

- Strong asset side position: KVB, a regional banking player in Southern India, has carved out a niche for itself by catering to working capital requirements with clear preference towards secured credit. Capitalising on its regional focus, KVB has churned out consistent RoA (1.6%) & RoE (~20%) during FY06-FY12 - encompassing varied operating environments. This is result of a strong asset side position and deep understanding of its niche areas (traders, gold loan) which has translated into strong pricing power (3.2% decadal avg NIM) and low credit costs (40bps decadal avg). Clearly, KVB has worked around its weakn liability side (decadal avg CASA @ 24%) by strengthening asset side position over the years.

- Renewed focus on liability side: KVB has stepped up efforts to strengthen its liability side including 1) aggressive branch expansion with large share of new branches in non-home state locations 2) product innovation and business process reengineering and 3) array of changes (based on BCG consultations) to address challenges in scaling up to a pan-India commercial bank. The benefits of the efforts underway should be visible over the medium to long term.

- Well positioned to tide over NPA cycle: Asset quality remains robust (%GNPA at 1.5%) with limited restructured assets (2.2% of loans). Cumulative slippages in restructured assets have been very low (~7% of total) with risk of additional slippages lower as large part of restructured accounts are out of moratorium. Concerns over high textile exposure (~8%) seem overdone as better credit selection has prevented significant slippages so far. Exposure to government owned power companies (especially TNSEBRs2500mn) could remain an overhang until potential restructuring in H1FY13.

- Extent of valuation discount unjustified: KVB compares well with leading private sector peers on growth (loans growth at 25% CAGR during FY06-FY11), profitability (RoA of +1.5% and RoE of +20%) and quality (%GNPA at 1.45%, restructured at 2.2%, PCR at 80%). Despite that, KVB trades at a significant 50% discount to avg PBV of five quality private banks. Moreover, south based peer banks (FED, CUB, SIB) are trading at par with KVB despite lagging in many matrices. While some valuation discount to quality private banks can be justified on account of the size of operations and scalability challenges, the extent of discount currently is unjustified and we expect it to narrow down going ahead. We value KVB at Rs500 (based on1.5x FY14E BVPS) and initiate coverage with Buy.

Source : Equity Bulls

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