Kotak Mahindra Finance (KMFL) has shown a sharp turnaround in its first quarter interest income, which rose by 16%. Its profits were however, depressed due to a steep decline in operating margins. The company is in the process of converting itself into a bank and aims to start operations as a bank in November 2002.
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During the quarter, KMFL derived over 25% of its total revenues from investments in group companies, which are currently yielding relatively low returns on capital employed compared to its lending business. The company's investments in insurance business, which has a long payback period, is mainly responsible for an overall lower yield on investments.
Operating margins of KMFL declined, as it included costs incurred towards the process of conversion. Professional fees paid by the company witnessed a 7 fold rise, inflating the total operating cost. KMFL had received clearance from the RBI in February 2002 to become a bank within a year. The bank will start its operations with a networth of Rs 5.5 bn and all companies in the group, which offer allied financial services will become subsidiaries of the new bank. The company is planning to recruit 200 people over the next three months as part of this conversion. This is likely to increase its staff cost, which was lower by 11% in the June quarter. As a result, operating margins are likely to dip further from the current 22% and cost to income ratio could increase from 34% in June quarter.
As part of its operations, the bank will target mainly small and medium enterprises to expand business. Exposure to large corporates will be limited to structured loans, currency swaps operations, commercial papers, debentures and other fee-based activities. The bank is planning to implement 'Flexcube' core banking solutions and it is in the process of relocating its 30 branches to busy centers from remote areas. KMFL's network expansion and restructuring plans will lower its operating margins in the coming quarters.
At the current market price of Rs 160, KMFL is trading at a P/E of 20x 1QFY03 annualised earnings and price to book value ratio of 2x. The company's valuations are higher compared to private sector banks in general. The stock could witness some selling pressure with lower profit growth in the near term due to rise in operating cost.
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