Axis Bank's Q2FY19 results (Outperformer) - Turnaround even before the new CEO joins

Q2FY19 result highlights

• AXIS Bank reported a strong set of numbers with substantially lower slippage, a material reduction in watch list, improving PCR, healthy NIM, and continued traction in retail fees. PAT of Rs7.9bn grew 83% yoy and 13% qoq, in line with consensus. Core PPOP grew 16% yoy/-7% qoq
• Slippage declined substantially to Rs27.7bn versus Rs45bn qoq, the lowest since 4QFY16. Corporate slippage was low at Rs11bn with a large proportion of 88% from the watch list.  Recoveries declined qoq to Rs22bn due to absence of lumpy recoveries from NCLT which were available in 1Q.  The recovery rate ex-lumpy accounts remained healthy. GNPAs reduced 5% qoq to 5.96% in 2Q versus 6.52% in 1Q. Credit cost declined to 2.4% from 2.9% qoq. Management expects credit cost to fall sharply in 2H (normalized credit costs is 1.1%).
• Total stress loans declined to 9.7% from 10.7% qoq. Size of the watch list including non-fund declined by 8% qoq to Rs195bn. Watch list now stands at 3.8% of loans with the BB portfolio (including non-fund) at 2.2%. Additions to the BB portfolio were very low while upgrades were high mainly from steel accounts.  
• Domestic loans grew 15% yoy but overseas loans declined 12% yoy, pulling down overall loan growth to 11% yoy and 3% qoq. Retail and SME grew strongly at 20%yoy/5%qoq and 14% yoy /6%qoq and these now account for 61.8% of total loans versus 60.9% qoq. Corporate loans remained flat yoy /qoq.
• Domestic NIM declined 10bps qoq to 3.36%. Excluding recovery from NCLT in 1Q, core NIM has improved 5bps qoq. NII grew 15% yoy and 1% qoq. Savings deposits grew 14% yoy and 5% qoq. Retail deposits also grew strongly at 21% yoy.
• Non-interest income grew 4% yoy but declined 8% qoq. Core fees grew 9% yoy and 12% qoq. With strong growth, contribution of retail fees improved further to 62% from 61% qoq.

Valuation and view: 

We are marginally cutting FY19 earnings (MTM provisions and lower other income) but increasing FY20 earnings on higher NIMs and lower provisions. We expect RoE of 14% in FY20. We are retaining our TP of Rs750 on a target multiple of 2.4x PBV FY20E. We reiterate Outperformer. There are concerns that the new CEO joining in November will kitchen-sink but we believe with steady improvement in asset quality in the last two quarters, there are not many lumpy accounts left to slip. As such we do not see kitchen sinking as a big risk for AXIS. We believe earnings for AXIS have already turned around before the new CEO can join. With the peaking of NPLs, likely improvement in RoE in FY20 and a well-reputed CEO with proven, successful track record, AXIS is a must-buy in our view. With an over-emphasis on asset quality, the market has under appreciated the transition in fees (from lumpy to granular) for AXIS while lumpiness in fees remains a key risk for other private banks like IIB and YES. We believe the valuation discount of AXIS to IIB should narrow further with all the re-rating triggers in place.  AXIS Bank’s current deputy MD, Mr V. Srinivasan will not be considered for re-appointment after his term ends on Dec-20, 2018. The new CEO will join the bank on Nov- 19, 2018.