Federal Bank - Weak core performance - Centrum

FED's Q1FY13 core performance came in weaker than expected (PPP at Rs3.5bn vs Rs3.8bn estimated) led by 15bps NIM contraction QoQ and slightly higher opex. However, bottomline was in line led by materially lower provisioning costs. High slippage rate (3%) and significant addition to restructured book (Rs2bn) for the quarter were disappointing. Given the limited upside to our fair value estimate, we downgrade the stock to Reduce.

NIM contracts by 15bps QoQ: NII grew by a muted 7% yoy and flattish QoQ to Rs4.9bn as NIM contracted by 15bps QoQ offsetting healthy credit growth (19% YoY). Importantly, the NIM is the result of material dip in investment yields (~40bps QoQ) while loan yields stood flattish QoQ. The normalisation of NIM is likely to continue, led by gradually shifting the loan mix in favour of the corporate segment (besides the sector-wide challenge of rising funding costs).

Corporate segment drives loan growth: Following the trend in recent quarters, the corporate loan book continued to remain the key loan growth driver as the management leveraged its equity further. Corporate loan growth stood strong at 24% YoY compared with 15.6% for SME and 14% for the retail segment. Importantly, the bank witnessed strong traction in gold loans (up 99% YoY and 18% QoQ), which resulted in an increase in the share of gold loans in the overall loan mix to 11.2% from 9.5% in 4QFY12.

Slippage rate high at 3%: While lower than the quarterly avg of 3.6% during FY12, the slippage rate still remains high at 3% - led primarily by the corporate segment (one big ticket account) during Q1FY13. Consequently, GNPA worsened by 25bps QoQ to 3.6% while PCR saw 150bps erosion QoQ. Meanwhile, incremental restructuring of Rs2bn (including Rs800mn towards UPSEB & Rs500mn towards one large construction sector exposure) took the total stock to Rs17.5bn (4.6% of loans).

MTM write-back contains provisioning cost: Total provisions were down materially on YoY basis led by lower NPA provisions as slippage rate improved on YoY basis. Moreover, the bank benefitted from a significant MTM writeback (Rs205mn) which helped contain the overall provisioning cost at 65bps. We have factored in credit cost of 110bps for FY13 and FY14 in line with our cautious stance on asset quality trends.

Weak core fee income performance: Non-interest income grew by muted 6.4% YoY during the quarter led by 3% YoY de-growth in core fee income and a weaker recovery performance. However, treasury revenue streams were strong for both gains on the sale of investment and forex transactions.

Downgrade to Reduce: The management's strategy to enhance RoE by optimally leveraging the equity while at the same time shift away from high risk-high yield to a lower risk-lower yield book is gradually yielding results (albeit mixed). The strategy should lead to further normalization of NIM in the near term while benefit on asset quality will be visible over the medium term. Hence we believe that expansion of RoE is likely to be a multi-year effort with multiple challenges on the way. At the current price, the stock is trading at 1.1x FY14E ABVPS and seems to be fairly valued with just 3% upside to our price target of Rs450. We recommend investors to reduce exposure on rises.

Source : Equity Bulls

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