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Kotak Bank: In consolidation phase - Views on News from Equitymaster
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Kotak Bank: In consolidation phase
Jun 15, 2005

Performance Summary
Breaking off from its poor streak, Kotak Mahindra Bank (standalone) posted a decent (8% YoY) growth in bottomline for FY05. The same can be primarily attributed to 12% profit growth in 4QFY05. As against this, the groupís consolidated bottomline dipped by 3% YoY in FY05. The bank continued to post a strong topline growth (46% YoY), which also filtered into the net interest income (32% growth YoY). However, the extraordinary jump in operating overheads dampened the operating margins.

  Kotak Bank (standalone) Consolidated financials
Rs (m) FY04 FY05 Change FY04 FY05 Change
Income from operations 2,883 4,203 45.8% 6,362 7,761 22.0%
Other Income 948 1,321 39.3% 5,285 9,350 76.9%
Interest Expense 1,175 1,948 65.8% 2,529 3,286 29.9%
Net Interest Income 1,708 2,255 32.0% 3,833 4,475 16.7%
Other Expense 1,392 2,245 61.3% 5,711 10,551 84.7%
Operating Profit 316 10 -96.8% (1,878) (6,076) 223.5%
Operating profit margin (%) 11.0% 0.2%   -29.5% -78.3%  
Provisions and contingencies 57 147 157.9% 100 178 78.0%
Profit before tax 1,207 1,184 -1.9% 3,307 3,096 -6.4%
Tax 420 335 -20.2% 1,303 1,157 -11.2%
Profit after tax/ (loss) 787 849 7.9% 2,004 1,939 -3.2%
Net profit margin (%) 27.3% 20.2%   31.5% 25.0%  
No. of shares (m)       123.3 123.3  
Diluted earnings per share (Rs)       16.3 15.7  
P/E (x)         25.4  

Aiming high
A flagship company of the well-known financial conglomerate Kotak Mahindra Group, Kotak Mahindra Bank was the first banking entity in the country created by conversion of an FI in 2003. The bank had 38 branches across 25 cities in India at the end of FY05 and plans to increase its network by 45 to 70 branches by FY07 across 40 to 50 cities. The capital adequacy ratio of the bank stood at 12.8% at the end of FY05. The bank has subsidiaries in diverse businesses such as securities broking, investment banking and life insurance. Besides Kotak Securities (46%), Kotak Bank is the only major contributor to the groupís bottomline (34% in FY05).

What drove performance in FY05?
Retail skewed:  Retail assets, which comprise 32% of the bankís total loan book, have been the largest contributor to the bankís growth in FY05 (89% advances growth). The assets in this segment have amplified by 74% YoY in FY05 and the revenues generated from this segment have shown an equivalent growth. The home loan segment of the bank has trebled on a YoY basis in FY05, although on a lower base. The corporate segment on the other hand, despite witnessing a decline in asset volumes continued to be a significant contributor to revenue (28%). Due to higher credit offtake, the exposure on the treasury side has increased marginally and in a rising interest rate scenario the same has not been very profitable.

Segmental revenue (standalone)
  FY04 % of total FY05 % of total Change
Retail banking
Assets 18,175 22.0% 31,587 40.0% 74%
Revenue 1,973 43.4% 3,440 51.5% 74.4%
Profit 618 60.4% 816 88.7% 32.0%
Profit margin 31.3%   23.7%    
Corporate Banking
Assets 32,259 39.1% 15,010 19.0% -53.5%
Revenue 1,292 28.4% 1,897 28.4% 46.8%
Profit 237 23.1% 252 27.4% 6.3%
Profit margin 18.3%   13.3%    
Treasury
Assets 32,049 38.9% 32,301 40.9% 0.8%
Revenue 1,280 28.2% 1,340 20.1% 4.7%
Profit 169 16.5% (148) -16.1% -187.6%
Profit margin 13.2%   -11.0%    
Total
Assets 82,483   78,898   -4.3%
Revenue 4,545   6,677   46.9%
Profit 1,024   920   -10.2%
Profit margin 22.5%   13.8%    

Swelling overheads:  The overheads of the bank have been a significant drain on the bottomline in FY05. The bank attributes this to expansion initiatives and hopes to generate handsome revenues from the same going forward. This will however, take a couple of years to fructify and will until then continue to prune the bankís operating margins.

Other income:  The other income for the bank continued to augment in the third quarter on the back of fee income garnered by the cross selling of products of its subsidiaries. The bank acts a third party distributor for most of the products of the groupís asset management and insurance business.

Other income breakup...
Consolidated FY04 % of total FY05 % of total Change
Fee income 2,704 51.2% 3,990 42.7% 147.6%
Insurance premium 1,465 27.7% 4,609 49.3% 314.6%
Profit on sale of invst 978 18.5% 445 4.8% 45.5%
Other income 137 2.6% 306 3.3% 223.4%
Total 5,284   9,350   176.9%
Lucrative subsidiaries:  The groupís other income has grown by a significant 177% in FY05. Of this, fee income (constituting 43% of the total other income) has grown by 147% YoY. One of the most significant contributors to the other income side has been the insurance premium garnered by the life insurance subsidiary that has grown by 315% YoY. Also, amongst the other subsidiaries, Kotak Securities clocked average daily volumes of around Rs 11 bn during FY05 (against Rs 7 bn in FY04). Going forward the bank hopes to unlock substantial value from these subsidiaries.

What to expect?
The bank has announced a 3:2 bonus (3 bonus shares for every 2 shares already held). With this the paid up share capital of the bank will cross the minimum requisite Rs 3 bn mark for private banks. However, a capital adequacy ratio of 12.8% does not seem sufficient to fuel future growth and the bank may have to resort to additional Tier II borrowings.

At the current price of Rs 397 the bank is trading at 3.3 times its FY05 adjusted book value. While the same does not look attractive, we do acknowledge the fact that the bank being a well-diversified entity holds considerable potential going forward. The bank seems to have been very conservative in terms of asset quality (net NPA to advances 0.3%). Also, the fact that the bank despite being a relatively new entrant in the private banking space is not a novice in dealing with the dynamics of the financial sector, acts as a comfort. While investors could continue to remain invested in the stock (with a long term perspective), fresh investment at the current levels is not advisable.

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