Kotak Mahindra Bank's Q1FY19 results (Outperformer) - A soft quarter but a valuable franchise.

Q1FY19 result highlights

• KMB’s PAT of Rs10.2 bn was lower than the consensus estimate of Rs12bn. PAT growth of 12% yoy  (decline of 8.8% qoq) was lower than 15% in 4Q18 and 20% in FY18. The miss was driven largely by higher provisions and to a smaller extent by lower NIMs. While net profit growth slowed compared to the last quarter, growth in operating profit was strong at 27% yoy and 0.7% qoq.
• The bank booked MTM provisions of Rs2.1bn and chose not to use RBI’s dispensation of amortization. The MTM provision was higher than Rs1.3bn qoq. Loan loss provisions rose sharply qoq though slippages were under control because the bank cautiously provided more towards business banking.
• NIMs declined 20 bps yoy and 5 bps qoq to 4.3% due to lagged repricing of variable rate loans under the MCLR regime. NII grew 15% yoy and was flat qoq. Core fees declined qoq due to seasonality around insurance sales and distribution.
• Loans grew strongly at 24% yoy and 4% qoq. While growth in business banking remained weak, growth was strong in most other segments. Corporate loans grew strongly at 25% yoy and 11% qoq.
• Growth in savings deposits remained strong at 2% qoq and 51% yoy. Growth in average savings was also strong at 59% yoy and 6% qoq.
• GNPAs rose marginally by 1.9% qoq but net NPAs declined 5% qoq as the bank improved provisioning cover by 500bps. The bank made higher provisions towards business banking.

Valuation and view

While earnings growth of 12% looks low for a stock like Kotak that trades at a premium to the sector, PPOP growth of 27% is still healthy relative to other banks and asset quality remains superior. As such we remain Overweight on the stock. There are only a few banks with high standards of corporate governance, excellent risk management practices and superior asset quality and Kotak is one of them. With dearth of banks having good asset quality and corporate governance becoming an important investment theme, we believe Kotak’s valuation premium to the sector could expand. We are revising our target multiple on the core bank to 4.8x from 4.2x and revising our TP to Rs1,500. Kotak continues to be a valuable banking franchise for the long term. However the stock could consolidate in the short term because it rallied strongly on the back of better than expected 4Q18, while 1Q PAT was below expectations. Mr Uday Kotak warned that overvaluation of collateral for SMEs is a risk that could play out in a big way for banks and NBFCs. Kotak Bank has taken corrective measures to address this risk.