IndusInd Bank shares: A straddle can be a stretch

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IndusInd Bank’s business model straddles an NBFC (focus on CV/auto lending,higher wholesale funding,flexible distribution) and a private-sector bank (capital,products,deposits,fees). NBFC gains have been stellar,but future growth will likely be less dynamic,amid a tougher macro,and less unique (auto NBFCs are queuing for bank licenses).

IndusInd Bank has concentrations in loans (almost 50% to auto buyers),deposits (50% are wholesale),customer exposures (highest among peers in terms of top 20 borrowers/lenders) and dependence on fee income (consistently exceeded loan growth). While this approach has boosted growth and profitability in the past,it could raise BS/P&L and valuation risks in slower/tougher times (auto is the current risk).

The management has a cohesive strategy and the capital for its next stage of growth. We expect 25% asset growth (among the highest in the peer group),improved funding (CASA rising to 35% on pricing and distribution expansion) and a broadening of fee growth.

The bank merits a valuation premium,in our view,given its growth prospects,franchise,and management quality. However,we see fair value at 2.5-times the one-year fwd P/BV (15-times Sep ’14 estimated P/E),for a target price of Rs 455 (approximately 7% lower from here).

Our fair-value P/BV (30% discount to HDBK,25-30% premium to ICBK/Axis) reflects the likely peaking of IndusInd Bank’s hybrid model,its concentration and cyclical risks (auto),and still relatively early days in its growth and franchise creation cycle. The key upside risks are stronger execution,gains from falling rates and sustained business momentum.

IndusInd’s portfolio is skewed towards vehicle (CV/UV/Auto/2W) financing. This business has grown at a 36% three-year CAGR (compound annual growth rate),and forms 46% of the loan book (40% in FY10).

The bank is already a market leader,the industry is slowing and there are system-level asset quality pressures. Hence,while the business is retail and granular,these positives are offset by the sectoral concentration and consequent risk.

Additionally,it appears that IndusInd Bank’s corporate book,despite being mid-market (typically smaller ticket and more diversified),is more concentrated relative to peers.

This is reflected in its higher loans and credit exposure concentrations,even versus perceivably more corporate-biased/less retail players (Axis,Yes). This is partly because IndusInd’s non-auto portfolio book is small and so the numbers stand out,but it is also reflective of this being a relatively modest and early-stage franchise.

IndusInd’s gains appear quite meaningful on the funding front – its CASA (current and savings account) ratio increased from 15.7% in FY08 to 29.3% in FY13. However,despite this cushion,IndusInd’s average deposit cost has been fairly stubborn (mix of macro deposit slack and micro competitive increase) and in fact rose in FY12/13 (on account of savings account share grab with higher pricing).

Deposit costs for IndusInd Bank are the highest among peers and have risen the most in the last two years,while its deposit concentration (% of top 20 depositors) is also the highest across peers at 25%.

IndusInd Bank’s wholesale deposit funding is also well ahead of peers,being about 50% of total deposits. While management sees this as part design—giving flexibility in funding (particularly currently,when rates are expected to fall),and facilitating funding matches and pricing—we do see this as a little vulnerable to liquidity,and the market tends to discount this as a funding model.

—Citi Research