Buy Bandhan Bank for 26% upside or Rs. 415 Target Price: Edelweiss

Faster growing mid-sized bank before the pandemic

Prior to the outbreak of the pandemic, Bandhan Bank was the fastest growing bank and recorded a CAGR of 42% credit growth in FY 2016-20 (in terms of organic growth). However, after the onset of the pandemic, credit growth fell to 12% between Q4FY20 and Q3FY22. Although assets were affected, the bank continued to maintain a strong growth trajectory on the deposit front. So, similar to higher credit costs and weak loan growth, the bank’s RoE and RoA were severely impacted, with RoA and RoE dropping to 2.2% and 13.5% over the course of the year. FY21, compared to a peak of 4.5% and 28.6% in FY17.

The Brokerage's View of the Lender:

The Brokerage’s View of the Lender:

Edelweiss is of the view that Bandhan Bank, which faced such hardship given the Covid woes and state-related issues, is behind it now. As there is an upturn in economic activity and the government-related issues have settled down, it is believed that credit growth as well as asset quality issues have diminished.

Rationale for a “buy” on Bandhan Bank as given by the brokerage:

Rationale for a “buy” on Bandhan Bank as given by the brokerage:

Quality of assets to be improved only:

The bank has a very high presence in West Bengal and hence the state-specific challenges have hit it badly. Nonetheless, slippages are expected to be contained and asset quality to improve going forward. This change is already reflected in the numbers. EEB (Bandhan MFI segment) collection efficiency increased from 86% in Q1FY22 to 96% in Q3FY22. Overall stress in the EEB book increased from INR 195 billion (36% of book size) in Q2FY22 to
INR170bn (~30% of book size) at T3FY22.

Moreover, the bank is well covered to deal with stress to the tune of Rs. 170 billion in the EEB book with provisions of Rs. 92 billion. It is said that there is a significant drop in the cost of credit and that certain provisions should decrease and therefore translate into profitability.

So, as there is a decline in GNPA for retail and commercial banks, the housing segment is experiencing misfortunes or a slight increase in NPA due to issues with the self-employed class.

Strong momentum across all segments to drive loan growth

Strong momentum across all segments to drive loan growth

The Bank experienced strong loan growth before the pandemic, but as collections normalize and the asset crunch eases, Bandhan can focus entirely on growth. Additionally, small business cash flow has improved significantly, helped by a strong recovery in economic growth. There was an increase in the loan portfolio of 9.6% during the third quarter period and disbursements recorded an increase of 32% YoY and 61% QoQ. “We expect advances to grow at a CAGR of 20% in FY21-24. Housing and CB and Retail will be the main drivers of growth due to management’s strategy to reduce the share of EEB Group loans in the overall mix to 30% by FY25, from 52% currently.

Granualr Deposit Franchise Offering Superior Margins:

Granualr Deposit Franchise Offering Superior Margins:

CASA increased at a robust CAGR of 39% between Q3FY19 and Q3FY22, and the CASA ratio increased by 420 bps to 45.6%. This ratio is comparable to that of most major private banks. By comparison, the CASA ratio of most mid-sized banks hovers between 25% and 35%. At 5.2%, Bandhan’s cost of funds is still higher than most banks due to the higher rates offered on deposits. However, a downward trend is clearly seen, with the CoF having fallen by 200 basis points over the past eight quarters. This allowed the net interest margin to be largely maintained in the 7-8% zone despite high slippages. On the growth front, we believe Bandhan’s plan to add 1,200 branches over the next three years will allow it to rapidly increase its deposit base.

Return ratios to regain pre-Covid levels:

Return ratios to regain pre-Covid levels:

“We expect Bandhan Bank’s NIM to moderate slightly from now on as the cost of funds bottoms out and the bank’s returns will soften due to the shift to collateralized products such as loans. However, the impact of these factors on the NIM will likely be offset to some extent by the reduction in slippage and, therefore, interest write-offs,” the brokerage adds.

Additionally, as asset quality improves, there will be a reduction in credit costs and this will also be helped by the growing share of secured products in the mix. We expect the bank to announce a cost of credit of around 2.2% in FY24E, compared to around 5% in FY21. This will likely translate to the bank reporting RoA and RoE of around 3.5% and 25% in FY24E, compared to around 2.2% and 13.5% in FY21, respectively.

Valuation and prospects:

At CMP, shares of Bandhan are trading at 2.0x FY24E ABV. We believe the stock has the potential to trade at 2.5x FY24E P/ABV given our forecast RoA of 3.5% and RoE of 25% for FY24E. We are repeating our “BUY” trade on Bandhan Bank with a target price of INR 415 per share, which translates to a 24% upside.

Warning:

Warning:

The view and the “Buy” on the stock is as given by the brokerage firm. Readers and investors should not construe the story as investment advice, please engage in your own due diligence.

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