Kotak Mahindra Bank's Q4FY18 results (Upgrade to Outperformer) - Strong operating performance

Q4FY18 result highlights

• KMB’s PAT of Rs11.2bn grew 15% yoy and 7% qoq. PAT was lower than consensus due to gratuity provision of Rs820M. While the bank had a one-time gratuity cost of Rs820M and an MTM provision of Rs1.3bn which was higher than expected, NII and core fees were also higher than expected and helped offset the negative impact of MTM/gratuity.  Operating profit grew strongly at 19% yoy and 11% qoq driven by strong loan growth, qoq NIM expansion and strong core fees. Asset quality remained robust. Gross NPAs grew only 3% qoq. SMA-2 loans continue to be the lowest in the sector at 0.04% of loans.
• Loans grew strongly at 25% yoy and 7% qoq. While growth in business banking remained weak, CVs and small business/personal loans grew strongly.
• Growth in savings deposits remained strong at 12% qoq and 58% yoy. Current accounts grew faster at 24% qoq and 16% yoy. CASA ratio improved to 50.8% from 46.7% qoq.
• Non-banking/non-lending subsidiaries reported strong earnings growth. The profit of life insurance, AMC, investment banking and broking combined grew strongly at over 27% yoy.
• For the first time, Kotak disclosed the relationship value of its wealth business which is housed under the bank. The value of the wealth business is Rs225bn.

For the first time KMB disclosed the EV and VNB margin of the life insurance business which were higher than expected. The EV as of March 31, 2018 was Rs58bn and the post-overrun VNB margin was 29.3%, the highest amongst peers. 13-mth persistency was healthy at 85.2%. With such strong margins, we are revising our value of the life business from Rs70 to Rs123 per share before subsidiary discount.

Valuation and view

We believe Kotak’s earnings will be better than the sector’s as Kotak does not face corporate stress seen in other banks. With strong standalone earnings and strong performance of subsidiaries, we believe Kotak stands out in a weak sector. With higher earnings growth and better quality of earnings compared to peers, we are upgrading the stock to Outperform. We are revising our target multiple of the parent bank to 4.2x PBV. We are increasing our fair value for life to Rs235bn from ~Rs130bn, valuing the business at 3x PEV FY20E.  Our consolidated fair value now stands at Rs1,360. The stock has outperformed the SENSEX by 14% in the last 3 mths. After the strong price performance, we recommend buying on dips.