Federal Bank - A Re-rating Candidate - Fairwealth

Loan Growth to Remain Healthy; Focus on High Yield Loan Book to Continue

Considering the demand slowdown and management's focus to improve asset quality, we expect FY13 loan book to grow at 16%, in-line with industry growth. Pick-up in demand will certainly boost the credit growth which is estimated at 20% for FY14. FedBk will stick to focus on SMEs and Retail being high yielding segments. We expect Corporate and non-corporate segment to account for 39% and 58% respectively in FY13 and FY14.

Gold and Home Loan To Remain in Focus

Pre-dominantly being based in south, Federal Bank has great opportunity of tapping the largest gold loan market using its well-entrenched network. We expect gold loan segment to grow at 50% pace in FY14. Apart from gold loans, FedBk will provide thrust on home loans (40% of retail portfolio in Q3FY13 as compared to 63% in FY11) to drive growth of the retail segment but will remain cautious in loan disbursement to this segment.

We Expect Margins to Moderate

Considering the erosion in low cost deposits post the RBI's deregulation of NRE term and saving deposits rates, we expect NIM to moderate to 3.3% and 3.2% in FY13 and FY14 respectively. However, Management has guided NIMs of 3.5%-3.6% for FY13E on account of rise in NRE term-deposits. In both cases, margins will remain better than its peer group.

Focus on Establishing a PAN India Presence

The Bank has systematic plans to scale up its presence across select geographies outside the state of Kerala, which include the States of Tamilnadu, Karnataka, Punjab, Gujarat and Maharashtra. We expect FY13 to end with ~1040 branches. We factor in addition of 140 branches in FY14, a majority of which would be located outside Kerala.

Asset Quality Likely to Improve in FY14

Higher recovery and reduction in unseasoned book is expected to lead improvement in asset quality. We expect the asset quality to improve over FY13/14, with GNPA coming down to 3.5%/3.1% from 3.85% in Q3FY13. Reduction in unseasoned book and improved risk management will lead to high inspection in fresh issuance of loan resulting in lower slippages and reduced in credit cost. As a result, we expect the slippage rate to come down from 1.8% in FY12 to 1.7% and 1.5% by FY13 and FY14 respectively.

Valuation: At the current market price of Rs 517, Federal Bank trades at 1.4x and 1.3x its FY13E and FY14E ABV respectively. Management's focus on high yielding traditional products with expanding its footprint outside Kerala intentionally will be the key driver to the earnings growth for the bank. An improvement in fee income, asset quality, employee productivity and a shift in brand perception would lead to a re-rating for the stock. We believe FedBk is a Structural Buy Idea due to its transformation and initiate coverage on Federal Bank with a BUY rating and a target price of Rs 609 implying 18% upside.

Key Risk: (1) Any substantial deterioration in economic environment may hamper the growth strategies (2) Higher slippages than anticipated will lead to deteriorated asset quality.

Source : Equity Bulls

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