Axis Bank's Q3FY18 results (Neutral) - Continued additions to BB portfolio is the key concern

Q3FY18 result highlights

• PAT of Rs7.2bn was 6% higher than our estimate due to lower than expected non-NPL provisions. PAT grew 25% yoy and 68% qoq on a low base both yoy and qoq. While a 600 bps qoq increase in provisioning cover partly driven by higher write-offs is a key positive, the continued addition of Rs20bn every quarter for the last 4-5 quarters to the BB portfolio is a cause of concern.  
• Loans grew 3% qoq and 21% yoy while total assets grew 11% yoy and 1% qoq. Loan growth was led by retail that grew 29% yoy and 5% qoq and SME that grew 27% yoy and 4% qoq while corporate loan growth remained low at 12% yoy and flat qoq.  Deposit growth was low at 10% yoy due to the base effect. Growth in savings deposits was also slow at 11% yoy and 1% qoq. While the low growth yoy can be explained by the base effect, the weak sequential growth in savings of just 1% is a negative. NIMs dipped 7bps qoq and 5 bps yoy.
• Slippages declined qoq to Rs45bn from a high base of Rs89bn, as expected. Corporate slippages were Rs29bn, 93% of which came from the BB pool. Recoveries and upgrades rose sharply qoq driven by 1) the upgrade of JSPL to standard and recovery in Aegis – both these accounts were downgraded in 2Q and 2) sale of NPLs of a little less than Rs20bn including Essar Global to private distressed funds. Gross NPLs declined 9% qoq. Write offs remained high at Rs28bn against Rs25bn qoq. Provisioning cover improved 600 bps qoq to 66% partly driven by higher write-offs.
• While NPLs declined qoq, total stress pool of BB accounts and watchlist remained flat qoq at Rs190bn which is negative. The BB portfolio stood at Rs161bn at end 3Q18, an increase of Rs3bn qoq. There was a gross increase of Rs32bn in the BB portfolio against which there was slippage of Rs29bn from this pool during the quarter leading to a net increase of Rs3bn. Of the gross increase of Rs32bn, Rs11.3bn was JSPL which got upgraded from an NPL to a standard BB loan. The remaining Rs20bn of increase is the recurring addition to BB which has remained steady at Rs20bn per quarter over the last five quarters led by power. Total stress loans now account for 11.82% of loans against 11.77% qoq.
• While NII growth was low at 9% yoy and 4% qoq due to slower asset growth, growth in fees was strong at 24% yoy and 4% qoq led by retail, SME and agri. Overall non-interest income declined 24% yoy despite a strong growth in fees due to lower trading gains. Core operating profit grew 17% yoy and 7% qoq.

Valuation and view

We cut earnings for FY18/19E and maintain Neutral. The continued increase in the BB portfolio is a matter of concern. With talks about a delay in the implementation of IFRS, we believe bad loan recognition will drag over several quarters. We revise TP to Rs605 as we add Rs35 for subsidiaries. We value the core business at 1.9x PBVFY20E. Prefer ICBK over AXIS given the valuation discount.