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1 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Recommendation
Buy at CMP and add on Dips
Add on dips to
Rs. 140-155
Target
Rs. 181-210
Time Horizon
4-5 Quarters
Industry
Banking
CMP
Rs. 155
Established in 1924 at Mangalore, Karnataka Bank (KBL) is a leading Scheduled Commercial Bank in India. The
bank took shape in the aftermath of patriotic zeal that engulfed the nation during the freedom movement of 20th
Century India. Over the years the Bank grew with the merger of Sringeri Sharada Bank Ltd., Chitradurga Bank
Ltd. and Bank of Karnataka. In 9 decades of its presence KBL has built network of 773 branches spread across 21
states and 2 Union Territories. It has forayed into General Insurance business as a JV partner in Universal Sompo
General Insurance with a 15% stake.
We recommend investors to buy the bank at CMP and add on declines to Rs 140 (0.8x FY20E ABV) for sequential
targets of Rs. 181 (0.9x FY20E ABV) and Rs. 210 (1x FY20E ABV) in the 4-5 quarters.
Investment Rationale:
Expanding Reach: Over the past 5 years the pace of branch additions at KBL has increased sharply. The bank
has added ~53 branches annually on an average in the last five years taking the branch network from 550 in FY13
to 765 at the end of FY17. The number of ATMs have increased from 504 in FY13 to 1380 in FY17. Under the Vision
2020 document adopted by the bank, it is aiming to achieve 1000 branches and 2500 ATMs by 2020. Bank is also
expanding its reach in Northern Region.
Retail portfolio and MSE segment to drive growth: Bank has adopted a strategy to increase exposure in retail
& MSE - high yield segments. The change in stance was due to concern over asset quality and slowdown in credit
growth in large corporate segment.
KBL has bouquet of products in the retail space like Housing Loans, Mortgages, Vehicle Loans, Gold Loans,
Education Loans, etc. Due to its high presence in the state of Karnataka majority of the demand for retail products
comes from within the state. Retail loans over the last 4 years (FY12-FY16) have grown at CAGR of 7.9% while
corporate loans de-grew by 1% CAGR over the same period.
Bank has also take several initiatives for growth of MSE segment and these initiatives have helped the bank to grow
its MSE portfolio which now accounts for 21.8% of its advances at the end of Q2 FY18 as compared to 16.9% in
FY14. The MSE segment has grown at CAGR of 28.8% over FY14-FY16.
Research Analyst
Kushal Rughani
HDFC Scrip Code KARBANEQNR BSE Code 532652
NSE Code KTKBANK Bloomberg KBL IN
CMP as on 10 Nov’17 155
Equity Capital (Rs Cr) 282.7
Face Value (Rs) 10
Equity O/S (Cr) 28.27
Market Cap (Rs Cr) 4420
Book Value (Rs) 182
Avg. 52 Week Vol 3590531
52 Week High 181
52 Week Low 100
Shareholding Pattern (%)
Promoters 00.0
Institutions 29.9
Non Institutions 70.1
PCG Risk Rating* Yellow
* Refer Rating explanation
2 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Well Capitalized: KBL has current CAR ratio of 14.4% with Tire-1 capital at 13.3%. Bank will use this
capital to support growth plans and to enhance the business. KBL raised capital through rights issue in Dec-
16 offered 1 share for every 2 shares held. The bank issued 9.42cr shares at a price of Rs 70 for funds of
~Rs 660 cr.
Asset Quality to Stabilize: Asset quality of KBL had deteriorated sharply over the past couple of years
on account of drought situation in Karnataka and economic slowdown faced by the companies in India. But
now the situations seems improving as management is taking active measures in restructuring the stressed
assets.
The bank has exposure to 4 cases with cumulative dues of Rs5.05bn towards cases referred to IBC (both
first and second list). The exposure towards first IBC case is at Rs490mn (carries provision to the tune of
Rs131mn); second list exposure is at Rs4.6bn; carries Rs917mn of provision against these accounts.
Stressed Assets Portfolio of the bank (GNPA + restructuring + SDR + S4A) is also in declining trend and
this shows bank’s focus on restructuring of stressed Assets. At the end of Q2FY18, total Stressed assets
has reduced to 6.5% of loans (vs. 8% in Q1’18 and 8.6% in Q4’17).
Management has guided GNPAs ratio to be reduced to 4% and the net NPAs ratio to 2% by end March
2018.
Growth to Accelerate: Between FY13-17 NII has grew at 13% CAGR, while Net Profit has grew at only
7%. We expect NII and Net Profit to grow at 22% and 21% CAGR between FY17-20E. Loan book has grew
at 10% between FY13-17 and we expect it to grow at 16% CAGR between FY17-20E.
The management is targeting to more than double the bank’s business to Rs 180,000 cr by FY20 and to
become a Preferred Banker to at least 1% of India’s population.
Dividend yield attractive: KBL has a dividend payout ratio in excess of 20%. In FY17 the bank declared
a dividend of Rs 4 per shares which translates to a dividend yield of ~2.6% on current market price. We
expect higher dividends to continue in the coming years.
Best in Class M&A Candidate: One of the key parameters to evaluate the potential value for Merger &
Acquisition of Small Bank by the larger ones is number of branch the acquirer can get. KBL has a very large
branch network in the South India with a strong franchise brand name. And also it is one of the cheapest
bank among the Private Banking space. Possibilities of stake acquisition by other Banks/financial institutions
or by institutional/foreign players could lead to a massive rerating of the stock.
Figure 1ufuyut
KEY HIGHLIGHTS
Karnataka Bank is a 9 decade old Franchise, with extensive presence in south India
especially in home state Karnataka.
The management is targeting to
more than double the bank’s business to Rs 180K cr by FY20 and to become a Preferred Banker to at least 1% of India’s population.
Emphasis on technology would result in cost reduction. Focus on
increasing CASA ratio, improving C/D ratio and shifting of business mix towards higher yielding retail and MSE loans would result in expansion of NIMs and improvement in return ratios.
Better monitoring of asset quality will bring down NPA
levels and lower the provisioning requirements. We recommend investors to buy the bank at CMP and add on declines to Rs 140 (0.8x FY20E ABV) for sequential targets of Rs.
181 (0.9x FY20E ABV) and Rs. 210 (~1x FY20E ABV) in the 4-5 quarters.
3 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Highlights for the Quarter:
Karnataka Bank recorded 25% decline in the net profit to Rs 93.4 Cr in the quarter ended September
2017. The profitability of the bank was impacted due to surge in provisions. The bottom-line were
also impacted due to higher tax provisions in Q2FY18 against write-back of tax provisions in
Q2FY2017. However, the bank has substantially improved margins and non-interest income.
NII grew by 10.8% YoY and 3.7% QoQ on the back of strong growth in credit and decline in interest
expenses which was reduced by 3.5% YoY.
Business of the bank increased at nearly steady pace of 9% YoY to Rs 97685 Cr in Q2FY18. Deposits
increased 7% to Rs 56558 Cr, while advances moved up 12% to Rs 41127 Cr at end September
2017. C/D ratio improved to 72.7% from 68.4% QoQ.
Advances increased 12% at Rs 41127 Cr in end this Quarter. The corporate advance moved up 17%
to Rs 20481 Cr, while the retail advance rose 8% to Rs 20646 Cr.
Bank has improved asset quality in this quarter with the reduction in fresh slippages. Gross slippage
at Rs 374 Cr showed improvement with slippage rate declined to 0.98% (1.35% in previous quarter).
During the quarter 1 SDR a/c of housing infra sector of worth Rs230 Cr was downgraded to NPA and
management asserted of carrying adequate provision against it.
GNPAs during the quarter and GNPA ratio reduced by 22 bps to 4.13% v/s 4.34% in previous
quarter. While NNPA came at 3.04% compared to 3.2% in previous quarter.
Risk & Concerns:
Highly concentrated to Southern Region
Competitive intensity in the retail
Deterioration of asset quality
4 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Peer Comparison:
BANK Mcap CMP P/ABV (x) P/E (x) FY17
(Rs cr) (Rs) FY18E FY19E FY20E FY18E FY19E FY20E GNPA NNPA Branches ROAA
Karnataka 4,371 155 0.97 0.89 0.80 8.05 6.82 5.51 4.2% 2.6% 765 0.70%
Federal 22,094 113 1.92 1.74 1.57 20.93 16.14 12.99 2.3% 1.3% 1,252 0.81%
CUB 10,781 162 2.89 2.45 2.08 18.00 15.58 13.06 2.8% 1.7% 550 1.50%
DCB 5,688 187 2.37 2.10 1.87 16.97 16.67 15.16 1.6% 0.8% 262 0.90%
Source: Company, HDFC sec Research
View & Valuation:
The management is targeting to more than double the bank’s business to Rs 180,000cr by FY20 and to become a Preferred
Banker to at least 1% of India’s population. It expects to increase its touch points to 3,500 with 1,000 branches and 2,500
ATMs. Emphasis on technology to increase Digital Banking by increasing the digital touch points would result in cost
reduction. Focus on increasing CASA ratio, improving credit-deposit ratio and shifting of business mix towards higher yielding
retail and MSME loans would result in expansion of NIMs and improvement in return ratios. Better monitoring of asset quality
will bring down NPA levels and lower the provisioning requirements. It is now critical for the bank to grow its advances
without impacting its asset quality and liquidity profile.
On relative valuations the bank seems cheap, while possibilities of stake acquisition by other Banks/financial institutions or
by institutional players could lead to a huge rerating of the stock.
We recommend investors to buy the bank at CMP and add on declines to Rs 140 (0.8x FY20E ABV) for sequential targets of
Rs. 181 (0.9x FY20E ABV) and Rs. 210 (1x FY20E ABV) in the 4-5 quarters.
5 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Five Quarters At A Glance
NII Growth Trajectory
Source: Company, HDFC sec Research
0%
5%
10%
15%
20%
25%
30%
35%
0
500
1000
1500
2000
2500
3000
FY15 FY16 FY17 FY18E FY19E FY20E
NII YoY%
Total Business
Source: Company, HDFC sec Research
7768984391
93737105892
120860
145000
0
20000
40000
60000
80000
100000
120000
140000
160000
180000
FY15 FY16 FY17 FY18E FY19E FY20E
Rs
Cr
Deposits Advances
Asset quality trend
Source: Company, HDFC sec Research
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
0
200
400
600
800
1000
1200
1400
1600
1800
2000
FY14 FY15 FY16 FY17 FY18E FY19E FY20E
GNPA (Rs Cr) NNPA (Rs Cr) GNPA NNPA
6 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Dividend payout has remained > 20%
Source: Company, HDFC sec Research
0%
5%
10%
15%
20%
25%
30%
0
5
10
15
20
25
30
FY15 FY16 FY17 FY18E FY19E FY20E
Rs
EPS DPS Payout % (RHS)
Advances Mix (Q2 FY18)
Source: Company, HDFC sec Research
Agriculture13%
Micro-Small Ent, 22%
Medium Ent3%
Large Ent11%
Housing13%
Other Personal
Loans, 6%
Others32%
Pace of branch additions has increased consistently post FY11
Source: Company, HDFC sec Research
0
10
20
30
40
50
60
70
80
0
100
200
300
400
500
600
700
800
900
1000
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Branches Addition
7 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Income Statement
Particulars FY15 FY16 FY17 FY18E FY19E FY20E
Interest Income 4698 4992 5185 5951 6889 8520
Interest Expenses 3530 3689 3695 4203 4617 5798
Net Interest Income 1169 1303 1491 1748 2272 2722
Non interest income 507 543 809 1188 775 1072
Operating Income 1676 1846 2300 2936 3047 3794
Operating Expenses 902 991 1304 1525 1770 2208
PPP 773 855 996 1411 1277 1586
Prov & Cont 214 327 528 792 547 616
Profit Before Tax 559 528 468 619 730 969
Tax 108 113 16 74 88 175
PAT 451 415 452 545 642 795 Source: Company, HDFC sec Research
Balance Sheet
Particulars FY15 FY16 FY17 FY18E FY19E FY20E
Share Capital 188 188 283 283 283 283
Reserves & Surplus 3201 3502 4860 5268 5741 6333
Shareholder funds 3389 3691 5143 5551 6024 6615
Deposits 46009 50488 56733 63707 71926 86769
Borrowings 1038 1051 833 1097 1077 1281
Other Liab & Prov. 1590 1470 1529 1476 1908 2155
SOURCES OF FUNDS 52026 56701 64237 71832 80935 96820
Cash & Bank Balance 2614 3045 3274 3695 4125 4512
Investment 14032 16257 20220 21661 23016 28634
Advances 31680 33902 37004 42184 48934 58231
Fixed Assets 292 307 721 1152 1626 2196
Other Assets 3408 3190 3020 3140 3235 3299
TOTAL ASSETS 52026 56700 64238 71832 80935 96872 Source: Company, HDFC sec Research
8 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Key Ratios Particulars FY15 FY16 FY17 FY18E FY19E FY20E
Return Ratios
Calc. Yield on adv 11.7% 11.3% 10.7% 10.9% 11.0% 12.0%
Calc. Cost of borr 7.9% 7.5% 6.8% 6.9% 6.7% 7.2%
NIM 2.6% 2.7% 2.8% 2.9% 3.3% 3.4%
RoAE 14.0% 11.7% 10.2% 10.2% 11.1% 12.6%
RoAA 0.9% 0.8% 0.7% 0.8% 0.8% 0.9%
Asset Quality Ratios
GNPA 3.0% 3.4% 4.2% 3.9% 3.3% 2.9%
NNPA 2.0% 2.4% 2.6% 2.4% 2.2% 2.0%
Growth Ratios
Advances 11.8% 7.0% 9.1% 14.0% 16.0% 19.0%
Borrowings 13.4% 9.7% 12.4% 12.3% 12.9% 20.6%
NII 10.7% 11.5% 14.4% 17.3% 30.0% 19.8%
PPOP 12.6% 10.5% 16.5% 41.6% -9.5% 24.2%
PAT 45.1% -8.0% 8.9% 20.4% 18.0% 23.8%
Valuation Ratios
EPS 24.0 22.0 16.0 19.3 22.7 28.1
P/E 6.4 7.0 9.6 8.0 6.8 5.5
Adj. BVPS 146.7 153.6 147.5 160.6 175.0 192.9
P/ABV 1 1 1 0.96 0.88 0.80
Dividend per share 5.0 5.0 4.0 4.0 5.0 6.0
Dividend Yield (%) 3.2 3.2 2.6 2.6 3.2 3.9
Other Ratios
Cost-Income 53.9 53.7 56.7 51.9 58.1 58.2
Credit-Deposit 69.8 68.9 67.1 65.2 66.2 68.0
CAR (%) 12.4 12.0 14.4 13.5 12.9 11.8
PCR (%) 34.0 32.6 38.4 39.8 34.0 32.7 Source: Company, HDFC sec Research
9 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Rating Chart
R E T U R N
HIGH
MEDIUM
LOW
LOW MEDIUM HIGH
RISK
Ratings Explanation:
RATING Risk - Return BEAR CASE BASE CASE BULL CASE
BLUE LOW RISK - LOW RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 20% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 15%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 15%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 20% OR
MORE
YELLOW MEDIUM RISK - HIGH RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 35% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 20%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 30%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 35% OR
MORE
RED HIGH RISK - HIGH RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 50% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 30%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 30%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 50%
OR MORE
10 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
80
100
120
140
160
180
200
Close Price
Rating Definition:
Buy: Stock is expected to gain by 10% or more in the next 1 Year. Sell: Stock is expected to decline by 10% or more in the next 1 Year.
11 | P a g e
Karnataka Bank PICK OF THE WEEK
Nov 13, 2017
Disclosure: I, Kushal Rughani, MBA, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or her relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Further Research Analyst or his relative or HDFC Securities Ltd. or its associate does not have any material conflict of interest. Any holding in stock – NO HDFC Securities Limited (HSL) is a SEBI Registered Research Analyst having registration no. INH000002475. Disclaimer: This report has been prepared by HDFC Securities Ltd and is meant for sole use by the recipient and not for circulation. The information and opinions contained herein have been compiled or arrived at, based upon information obtained in good faith from sources believed to be reliable. Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as an offer or solicitation of an offer, to buy or sell any securities or other financial instruments. This report is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity who is a citizen or resident or located in any locality, state, country or other jurisdiction where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject HSL or its affiliates to any registration or licensing requirement within such jurisdiction. If this report is inadvertently send or has reached any individual in such country, especially, USA, the same may be ignored and brought to the attention of the sender. This document may not be reproduced, distributed or published for any purposes without prior written approval of HSL. Foreign currencies denominated securities, wherever mentioned, are subject to exchange rate fluctuations, which could have an adverse effect on their value or price, or the income derived from them. In addition, investors in securities such as ADRs, the values of which are influenced by foreign currencies effectively assume currency risk. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. HSL may from time to time solicit from, or perform broking, or other services for, any company mentioned in this mail and/or its attachments. HSL and its affiliated company(ies), their directors and employees may; (a) from time to time, have a long or short position in, and buy or sell the securities of the company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. HSL, its directors, analysts or employees do not take any responsibility, financial or otherwise, of the losses or the damages sustained due to the investments made or any action taken on basis of this report, including but not restricted to, fluctuation in the prices of shares and bonds, changes in the currency rates, diminution in the NAVs, reduction in the dividend or income, etc. HSL and other group companies, its directors, associates, employees may have various positions in any of the stocks, securities and financial instruments dealt in the report, or may make sell or purchase or other deals in these securities from time to time or may deal in other securities of the companies / organizations described in this report.
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