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Federal Bank (Buy CMP 345 TGT 500)

 In Q3FY2011, Federal Bank reported a growth of 17.4% in net interest income (NII) and a 29.8% year on year (YoY) growth in net profits to Rs143 crore. Though NII growth was in line with our estimates, the profit after tax (PAT) came in lower than estimated due to higher non performing asset (NPA) provisions.

Business growth moderates as asset quality gains focus: The bank’s loan growth has moderated substantially compared to the industry levels due to an increase in the NPAs. The advances grew 11.4% YoY and 5% QoQ , mainly contributed by the corporate segment (+4.2% QoQ).

 Margins remain at healthy levels: The margins dipped by 13 basis points QoQ to 4.3% due to an increase in the cost of deposits which rose 15 basis points sequentially to 6.03 %. The proportion of low cost deposits (CASA+ NRI deposits) went up by 150 basis points QoQ to 35.5%.

 Incremental slippages continue to remain high at Rs321 crore (4.5% annualised), mainly contributed by the SME (Rs145 crore), corporate (Rs109 crore) and retail (Rs67 crore) segments and one large account of Rs94 crore. According to the management, the slippages are slowing in the retail and the SME segments and the bank expects to reduce NPAs through recoveries /selloffs.

 We have revised our estimates downwards to factor higher NPA provisions and slower business growth, thereby leading to a revision in our target price to Rs500 (1.5x FY2012 book value). Currently the stock is trading at an attractive valuation of 1.1xFY2012 book value. We maintain our Buy recommendation on the stock.