Company update: Axis Bank (Neutral) - Preferential allotment will help fast track NPL recognition, profit to remain weak

AXIS Bank’s board has approved preferential allotment of equity shares and warrants to a list of 9 marquee investors including the promoter LIC. The bank will raise a total of Rs116bn of which Rs90.6bn will be through the issue of equity and Rs25.6bn will be through convertible warrants. The issue accounts for 9% of existing market cap. The equity will be issued at Rs525 per share and warrants and at Rs565. The issue will add 200 bps to CET1. The last reported CET1 was 10.95%. Bain Capital is the largest investor in the allotment accounting for 59% of total followed by promoter LIC at 15%.

New capital will facilitate faster provisioning: While AXIS has not increased the size of its watch list unlike SBI and ICICI, the bank disclosed its BB portfolio in 2Q. The fund based non-overlapping BB portfolio was as big as 73% of the watch list. Combined with the watch list, fund based stress exposure which is not part of any restructuring scheme or NPL is 2.6% of loans and total exposure is 49% higher than the fund based exposure. We believe the new capital will lead to more stress recognition in line with the rest of the system and help the bank move towards IFRS provisioning sooner

Marquee investors to boost confidence, LIC’s investment a signal that there is no merger with Kotak: The list of investors in the allotment includes some big foreign institutional investors – Bain capital and the Capital group. Bain Capital will take up 59% of the total allotment. Investment by a large private equity player like Bain will raise investor confidence in the bank.  There have been press reports on Kotak Bank wanting to acquire AXIS. With the promoter LIC also investing a large chunk, we read this as a signal that the government (which is the owner of both LIC and SUUTI that are the key promoters of AXIS Bank) is not keen on any such merger.

Cut earnings, maintain Neutral: We are increasing our NPL and provisioning estimates, factoring in the dilution and cutting earnings for FY18. We do not see RoA of more than 1% in FY19E. Given the marquee list of investors we are raising our target multiple from 1.8x to 2x yielding a target price of Rs580. We maintain Neutral as we believe the capital will be used to accelerate provisioning and profitability will remain low. We believe ICICI offers better risk reward given the valuation differential and our belief that its earnings have bottomed out sooner than the rest of the sector’s.