Headwinds remain: We maintain our Add rating as the business environment remains challenging, especially with banks finding it difficult to pass on the rising cost of funds. We are cautious about the bank loan impairment/credit costs as we see them rising from current levels as economic growth is muted and companies have leveraged balance sheets. A comfortable capital position, a flexible business model that allows the bank to shift to retail loans and a high retail liabilities base drive our positive rating.
Maintain Add despite inexpensive valuation: We maintain the Add rating noting that valuations probably factor partial headwinds facing the bank, especially with respect to risks of loan impairment. We value the bank at 1.4x (times) book and 10x EPS (12 months forward) for RoE (return of equity) of 15%. We see limited earnings growth in the medium term as we expect credit costs to remain high.
Axis Bank's trading premium to peers is near its lowest at 0.6x, compared to a five-year average of 0.xX. Our positive rating is driven by (i) healthy tier-1 ratio of 12.3%, (ii) healthy liability profile (70% CASA and retail term deposits) and (iii) flexibility of the business model to shift to retail loans.
Cautious about corporate growth: Axis Banks pace of shift to retail loans has been quite surprising with the share of retail loans increasing to 30% of total loans from 20% in less than two years. Growth in loans to large companies has dropped to less than 10% year-on-year and importantly, the exposure of the top 10 sectors (funded) has been declining gradually. The flexibility of the banks model, allowing it to shift from corporate to retail loans gives confidence that it is well positioned to leverage opportunities in different segments.
Not too positive about impairment ratios: Axis Bank continues to report a fairly strong loan portfolio with relatively low impairment ratios, despite increasing stress in sectors (like infrastructure) where the bank has large exposure. With a large share of assets becoming operational/ closer to operational, we are concerned about the debt servicing capabilities of many private power companies. Large companies continue to benefit from fresh lines of credit or other refinancing methods, which is probably ensuring lower default ratios.
NIM to decline gradually; shift to retail could impact loan yields: We expect NIM (net interest margin) to remain under pressure especially after