Development Credit Bank - House in order; due for structural re-rating - Edelweiss

Development Credit Bank Ltd. (DCB) is a private sector bank which offers various commercial and retail banking products and services. DCB is a transformation story in the current Indian banking space. DCB's fundamentals have improved dramatically in the last 3 years since the new management took charge. We believe DCB is well poised to deliver on the FY14 operational goals. The bank is an attractive play, given its improving return ratios, strong asset quality and above industry loan growth.

Broad based transformation underway

DCB under the new leadership is undergoing broad based transformation. With the induction of a new management in 2009, the focus has shifted to profitability, asset quality and balance sheet health. Over the past 2 years, DCB has seen consistent expansion in profits, strong rebound in margins and decline in NPAs. The management's enhanced strategic clarity and execution capabilities are reflected in consistent uptick in the bank's operating metrics for the last six quarters. Going forward, strong loan growth post consolidation, improvement in CASA & retail deposit share, traction in fee income and stable provisioning requirements are expected to converge into strong earnings growth over FY13-15E.

Advances to grow ahead of industry average post consolidation

DCB's advances grew at a CAGR of 15% (below industry average) over the past 5 years mainly due to the bank's focus on improving asset quality and profitability. With stronger processes and risk management systems in place, DCB is all set to step on the growth momentum. We estimate a 30% CAGR in its loan book over the next 2 years, well ahead of industry average. Deeper penetration in the SME, Micro SME, Retail Mortgages, Commercial Vehicles, Gold Loans and Mid Corporate segments via introduction of new products and entry into new geographies would provide the necessary impetus.

Healthy asset quality with best in class provision coverage

DCB's gross NPA and net NPA ratios have been on an upward trajectory since FY08 due to increased slippages in unsecured retail loans. However, over the past few years, the new management has put in place strict processes to prevent further slippages and manage NPAs better. The bank has also been focusing on secured credit, which has helped improve its asset quality. Total stressed assets (restructured advances + gross NPA) are at comfortable levels of 3.8%. The bank's provision coverage ratio (PCR) is strong at 88%. Going forward, we expect asset quality to improve further in the coming quarters with Gross NPAs falling to 2.4% in FY14E and to 1.7% in FY15E.

Productivity gains to boost operating efficiency

DCB's cost ratios are one of the highest in the industry, with the Cost to Income ratio of 69% and Opex/Asset ratio of 2.4% as of FY13, which is a major drag on ROA. However, post the induction of new management, the bank has laid rentless thrust on reducing its cost ratios and improving prodctivity. As DCB attains scale, we expect cost-to-income ratio to improve significantly from 75% in FY12 to 59% in FY15E and Opex/Assets ratio to improve from 2.8% in FY12 to 2.1% in FY15E. Cost improvement would primarily be driven by a 77% increase in assets per employee from INR 3.6 crore in FY12 to INR 6.3 crore in FY15E.

Ripe for re-rating on attractive valuations, improving operating metrics; Initiate coverage with "BUY"

We believe DCB is an attractively priced bank compared to its peers at 0.9x FY15E adjusted book and 6.7x FY15E earnings, will deliver RoEs of around 14% and RoAs of 1.1%. In addition, Capital Adequacy Ratio (CAR) of 13.7% (Basel-II), Net NPAs of 0.7% and PCR of 88% make a strong case for the stock to trade at premium compared to the peer group's valuations. We value DCB at 1.3x FY15E adjusted book value, arriving at a target price of INR 66 (Upside potential of 39%).We believe that going forward, continued strong performance will drive re-rating in the stock.

Source : Equity Bulls

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