Dhanlaxmi Bankrkpspl.com/images/Dhanlaxmi_Bank.pdf · 2011. 5. 15. · Dhanlaxmi Bank has been able...

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1 Dhanlaxmi Bank Buy (Target Price: Rs 265) Market Data Price on reco. date (Rs) 127 (BSE) Mkt. Price BSE / NSE (Rs) 127 / 128 Change since reco. 0.2% 52-week High/Low (Rs) 212 / 95 NSE Symbol DHANBANK BSE Code 532180 No. of shares 85.1 m Free float 100.0% Market cap (Rs m) 10,808 Stockprice Performance Dhanlaxmi Index* 1-Yr -14.0% -7.0% 3-Yrs 24.0% -2.0% 5-Yrs 58.0% 2.0% Returns above one year are on a CAGR basis * BSE Smallcap index Rs 100 invested is now worth... Shareholding (Mar-11) Category (%) Promoters NIL Banks, FIs and MFs 6.5 FIIs 32.7 An 83 year old entity that will now live up to its name and motto of wealth creation! An entity set up in the sleepy town of Thrissur in Kerala in the year 1927 is unlikely to invoke too much interest amongst investors today. Add to that the fact that it has had two unsuccessful rights issues in the past. To top it all the average age of employees in the organization was nearly 50 years until very recently. Thus the entity has every quality to be written off by discerning investors looking for long term wealth creators. An obvious conclusion for anyone who has not had a chance to listen to the company's brilliant turnaround story. One steered by ex SEBI chief Mr G.N Bajpai. The man who fought for retail investors' interest at the regulator's end well before Mr C.B Bhave did. An entrepreneur Mr Raja Mohan Rao had a majority 37% stake in the bank until 2007. Being closely held in terms of ownership, the board of Dhanlaxmi Bank lacked any professional guidance. An attempt by Mr Rao to raise funds through a rights issue also failed in 2002. This was until the RBI guideline on limited shareholding forced Mr Rao to offload 27% stake in the entity. The stake was bought by a German Bank MM Warburg Schweiz and some foreign funds. They insisted on board members with professional expertise in running the bank. Mr B. N. Bajpai's then induction to the board made a dramatic change to the fortunes of Dhanlaxmi Bank. In the last 3 years, the bank transformed itself in every possible aspect. With 30 functional heads and a new CEO, Dhanlaxmi Bank had some of the best minds from its private sector peers now steering its own ship. Interestingly, it never compromised on its core traditional and conservative values. Ones that had helped the entity sustain a small but profitable business with good quality assets. Under Mr Bajpai's guidance, the senior management countered multiple challenges that dogged the bank's performance. One, the bank had very concentrated focus on a single state - Kerala. Two, its technological framework was so outdated that every employee did not even have an email account until 2008. The appearance and offerings of the branches had little scope to attract young customers. And most importantly, with two thirds

Transcript of Dhanlaxmi Bankrkpspl.com/images/Dhanlaxmi_Bank.pdf · 2011. 5. 15. · Dhanlaxmi Bank has been able...

Page 1: Dhanlaxmi Bankrkpspl.com/images/Dhanlaxmi_Bank.pdf · 2011. 5. 15. · Dhanlaxmi Bank has been able to sustain net NPA (non-performing assets) levels below 1% since FY08. Even in

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Dhanlaxmi Bank Buy (Target Price: Rs 265) Market Data

Price on reco. date (Rs) 127 (BSE)

Mkt. Price BSE / NSE (Rs) 127 / 128

Change since reco. 0.2%

52-week High/Low (Rs) 212 / 95

NSE Symbol DHANBANK

BSE Code 532180

No. of shares 85.1 m

Free float 100.0%

Market cap (Rs m) 10,808

Stockprice Performance

Dhanlaxmi Index*

1-Yr -14.0% -7.0%

3-Yrs 24.0% -2.0%

5-Yrs 58.0% 2.0%

Returns above one year are on a CAGR basis * BSE Smallcap index

Rs 100 invested is now worth...

Shareholding (Mar-11)

Category (%)

Promoters NIL

Banks, FIs and MFs 6.5

FIIs 32.7

An 83 year old entity that will now live up to its name and motto of wealth creation!

An entity set up in the sleepy town of Thrissur in Kerala in the year 1927 is unlikely to invoke too much interest amongst investors today. Add to that the fact that it has had two unsuccessful rights issues in the past. To top it all the average age of employees in the organization was nearly 50 years until very recently. Thus the entity has every quality to be written off by discerning investors looking for long term wealth creators. An obvious conclusion for anyone who has not had a chance to listen to the company's brilliant turnaround story. One steered by ex SEBI chief Mr G.N Bajpai. The man who fought for retail investors' interest at the regulator's end well before Mr C.B Bhave did.

An entrepreneur Mr Raja Mohan Rao had a majority 37% stake in the bank until 2007. Being closely held in terms of ownership, the board of Dhanlaxmi Bank lacked any professional guidance. An attempt by Mr Rao to raise funds through a rights issue also failed in 2002. This was until the RBI guideline on limited shareholding forced Mr Rao to offload 27% stake in the entity. The stake was bought by a German Bank MM Warburg Schweiz and some foreign funds. They insisted on board members with professional expertise in running the bank. Mr B. N. Bajpai's then induction to the board made a dramatic change to the fortunes of Dhanlaxmi Bank.

In the last 3 years, the bank transformed itself in every possible aspect. With 30 functional heads and a new CEO, Dhanlaxmi Bank had some of the best minds from its private sector peers now steering its own ship. Interestingly, it never compromised on its core traditional and conservative values. Ones that had helped the entity sustain a small but profitable business with good quality assets.

Under Mr Bajpai's guidance, the senior management countered multiple challenges that dogged the bank's performance. One, the bank had very concentrated focus on a single state - Kerala. Two, its technological framework was so outdated that every employee did not even have an email account until 2008. The appearance and offerings of the branches had little scope to attract young customers. And most importantly, with two thirds

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Public 35.8

Others 25.0

Total 100.0

of employees on the verge of retirement, the bank lacked agility and innovation. One by one each of these were ironed out.

Over the last 2 years the bank underwent a change in logo and brand identity. It opened 65 new age branches and nearly 400 ATMs outside Kerala. The technology framework for core banking was upgraded. While retaining the 1,400 existing employees, it added nearly 2,900 young employees. As a result the bank ended up with a customer base of 1.6 m in March 2011. Meanwhile, it tripled its loan book and quadrupled its deposit base over the past 3 years. Also its net NPAs shrunk from 0.9% in FY08 to 0.3% of advances in FY11. However, the cost of revamp dampened the near term profits and valuations.

We believe that it may take another 4 to 5 years for Dhanlaxmi Bank to feature amongst the best private sector banks in the country. With valuations at 0.8 times our estimated FY16 adjusted book value, we expect the stock to more than double in the next 2 years. Buying it at the current levels or lower can help investors lock in the long term upsides at dirt cheap valuations.

Investment Rationale

Capital rising on the cards: With an average annual growth rate of 50% in advances over the past 5 years, Dhanlaxmi Bank certainly needs more capital headroom to sustain the current growth rate. The bank plans to raise capital to the tune of Rs 10 bn in FY12, of which Rs 5 bn will be raised in FY12 itself. This will boost the bank's capital adequacy ratio (CAR, 11.8% at the end of FY11) as well as book value per share. We believe that although there will be a temporary dilution of equity with the capital raising, the long term benefits of the same will gradually filter into the return ratios. We see the bank's return on equity moving up by almost 8% between FY11 to FY16E.

Cost efficiency can do wonders to margins: Dhanlaxmi Bank

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lags most of its peers in the PSU (Public Sector Undertakings) and private sector in terms of cost efficiency. The bank's cost to income ratio has averaged at 72% over the past 5 years as against 40 to 50% for the sector. In FY11, the cost to income ratio was as high as 83% thanks to the franchise and employee additions over past two years. The reasons why the bank has not been able to dramatically cut costs with the use of technology is due to provisioning requirements for payment of gratuity (for old employees), replacement hiring as well as the rise in ATM costs. However, the operating efficiency ratios have shown signs of improvement in the past three years despite 50% point-to-point growth in branch franchise and tripling of employee base. Going forward, we expect the bank to have average cost to income ratio in the range of 70% to 74%. However, any further improvement in cost efficiency can do wonders to the bank's margins going ahead.

Sustainable asset quality: Despite its regional concentration, Dhanlaxmi Bank has been able to sustain net NPA (non-performing assets) levels below 1% since FY08. Even in absolute terms the bank's gross NPA levels have come down over the past two fiscals showing no signs of stress on asset quality. At the end of FY11, the bank had 34% of its retail loan book as gold loans and 22% as mortgages. These typically have very low slippage ratios. Also in terms of provisioning the bank had a provision coverage ratio of 60% at the end of FY11 and will take that up to 70% by FY12. We believe that with its conservative lending strategy and provision coverage, the bank will be able to sustain good asset quality going forward as well.

Defensive play on India's banking potential: Around 60% of India's population has bank accounts. Almost each of the 500,000 villages in India has access to a bank. Yet the banking system in India is one of the most under-penetrated. We have one of the lowest consumer loans to GDP ratio even amongst developing economies. The biggest opportunity for Indian and global banks is financial inclusion in the world's second most populated and second fastest growing economy. It goes without saying that

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banks with rural reach and technological backing take the cake here.

Dhanlaxmi Bank's ability to leverage its long relationship with some of the best-known business houses in south India is its biggest advantage. It enables the bank to not just increase its existing business but also offers the potential to penetrate into under-banked locations.

Further, a reasonable return on equity, improved efficiency and negligible NPAs are factors that make the bank resilient to endure a prolonged downturn, if any, without hurting shareholders' interest. Dhanlaxmi's potential in rural banking and micro lending make it an enviable play on the country's banking potential.

Investment Concerns

Stiff competition: At a time when banks across the sector are raising interest rates to counter the rise in cost of funds effected by the RBI, Dhanlaxmi needs to follow suit. In addition to some pricing pressure in its deposit book the bank will have to re-price its loans so as to sustain net interest margins. In FY11, Dhanlaxmi added around 600 customers to its base every day. However, going forward, the bank may also face stiff competition in new customer acquisition from other private sector and PSU banks.

Having said that we believe that an improvement in CASA (low cost deposits) proportion from 23% in FY11 and better product offerings will help the bank sustain some degree of stability in its net interest margins over the next 4 to 5 years.

Low contribution of fee income: Despite a 20% YoY growth in its fee income base in FY11, the contribution of fee income to Dhanlaxmi Bank's total income remained at just around 3%.This makes the bank's growth vulnerable to interest rate risks. The agreement with Bajaj Allianz for distributing non life insurance products and with UTI Mutual Fund for mutual funds services will also take some time to aid its fee income growth. The bank has also bought 15% stake in online broking survives company Destimoney. However, the bank's relations with emerging corporates are expected to help growth of non funded revenues going forward.

Regional concentration: Dhanlaxmi Bank has a regional concentration in southern India, particularly in the state of Kerala. At the end of FY11, approximately 40% of the bank's branches were located in the state and 73% of its advances were to customers from the state. Its regional concentration therefore exposes Dhanlaxmi Bank more acutely to any adverse economic or political adversities in the southern region as compared to other public and private sector banks that have a more diversified national presence.

Risky small caps: It is important to note that small caps are inherently more risky as compared to the blue-chip or mid cap stocks. That is the reason we do not recommend small caps to those having a low risk profile. Even for investors having an appetite for slightly more risk, it is advisable to invest not more than 15% of one's portfolio in small-cap stocks. Any individual small cap stock should not be more than 3% of your portfolio. The reason for this is that small-caps tend to react very sharply to market movements.

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Background

Set up in the town of Thrissur in Kerala in the year 1927 with a capital of Rs 11,000, Dhanlaxmi Bank is one of the oldest private sector banks in the country. This 83 year old entity has undergone a transformation of sorts in the past 3 years under the stewardship of ex SEBI chief Mr G. N. Bajpai. Its employee base has gone up from 1,400 odd in FY08 to over 4,500 in FY11 while the average age of employees has reduced from 45 years to a little over 30 years. The bank is primarily active in southern India and derives a major share of its business from the retail and SME segments.

Over the past ten years, the bank has grown its advances at an average annual rate of 29%. Its interest income and net profits have grown at average annual rates of 20% and 16% respectively during the same period. The bank had 276 branches and 469 ATMs at the end of FY11.

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Industry Prospects

Contrary to banking operations in most other parts of the world, the Indian banking entities showed strong signs of revival in FY11. While there are those that have pared their balance sheet sizes, others have prudently provided for possible slippages. Also, with the lower cost of funds in FY10, most banks reported higher margins (NIMs). Having said that, the incremental credit growth is anticipated to remain muted in FY12 with the supply of credit continuing to outstrip demand. With cost of funds moving up and little upside in margins, banks are expected to rely heavily on their fee income generating abilities in addition to their operating leverage. Also, most banks envisage higher loan restructuring and provisioning costs in the next fiscal, which may eat into their profits. Nonetheless, the Indian banking sector continues to remain very healthy as compared to its global counterparts in terms of systemic risks and safety of depositors' money. Key management personnel

Mr. Amitabh Chaturvedi, Chairman and Managing Director of Dhanlaxmi Bank, is a qualified Chartered Accountant. He was inducted into the bank in October 2008. He has over 18 years of experience in banking and finance.

Mr. Bipin Kabra, Chief Financial Officer at Dhanlaxmi Bank is a qualified cost accountant and chartered accountant. He too has over 18 years of experience in the banking and financial space including orgainsations like SBI and ICICI Bank. Risk Analysis

Sector: The growth in non-food credit is closely linked to the GDP growth of the country. With the contribution of non-food credit to GDP having grown from 28% in FY02 to above 60% in FY11, we see a higher proportion of the same being inevitable to keep the GDP growth of the country at a sustainable 6.5% per annum. Also, the rising income levels and ongoing capex drive of the corporates make the case strong for retail and corporate lending respectively. Nevertheless, given the hardening of interest rates, we expect a slowdown in incremental lending rates on certain counters in FY12, especially mortgage finance and non-collateral retail loans. Based on these factors, we have assigned a medium risk rating to the sector.

Company standing: Dhanlaxmi Bank, despite being one of the oldest private sector banks in India, is a small regional player. Also while the company scores well amongst its peers in terms of asset quality and profitability; it still has to compete with them for incremental business. High operating costs are also a hurdle to higher profits. We rate the company as having ‘medium' risk within its industry.

Revenue: Dhanlaxmi Bank has generated average annual interest income of around US$ 107 m over the past five years. During the latest completed fiscal (FY11), it clocked interest income of about US$ 206 m. We expect the same to grow at an average

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annual rate of 27% over the next 4 to 5 years. Based on the company's decent size in the small cap space, we assign a rating of 7 to the stock.

Advance growth: Dhanlaxmi Bank has seen its advances grow at an average annual rate of 49% over the past five years, which has been way above industry average rate. Over the next 4-5 years, we expect advances to grow by around 26% annually. The rating assigned is 5, which indicates medium risk.

Net interest margin (NIM): Dhanlaxmi Bank's NIM has averaged at 2.7% over the past five years, which is far above the industry average. We expect NIM to range between 2.4 to 2.6% even on a conservative basis during the next 4-5 years. The rating assigned is 5, indicating medium risk.

Long-term EPS growth: Dhanlaxmi Bank has grown its net profits at an average rate of over 29% over the past five years. We expect average annual growth over the next five years to be above 40% due to rationalizing costs and economies of scale. The rating assigned is 7.

Return on equity (ROE): ROE is an important tool to assess a company's potential to be a quality investment by determining how well the management is able to allocate capital into its operations for future growth. Dhanlaxmi Bank's last five years' average ROE of 10% may be below industry average. However, we see the bank witnessing a sterling improvement in the return ratio as the benefits of expanded franchise and additional capital start filtering in. We assign a rating of 4 to the stock on this parameter.

Dividend payout: A stable dividend payout history inspires confidence in the management's intentions of rewarding shareholders. Over the past five years, Dhanlaxmi Bank's dividend payout has averaged almost 16%. As such, the rating assigned is 5.

Promoter holding: A larger share of promoter holding indicates the confidence of the people who run it. We believe that a greater than 30% promoter holding indicates safety for retail investors. Since the promoters of Dhanlaxmi Bank had to liquidate their stake as per the RBI's minimum holding norms, the bank currently does not have a specific promoter. As such, we have not assigned any rating to the stock on this parameter.

FII holding: We believe that FII holding of greater than 20% can lead to high volatility in the stock price. At the end of March 2011, FII holding in Dhanlaxmi Bank stood at nearly 33%. Thus, the rating assigned is 2.

Liquidity: The average daily volumes in Dhanlaxmi Bank's shares over the past 52-weeks stand at around 173,000 shares, which we believe is comfortable for a small cap company. The rating assigned on this parameter is 6.

Net NPA to advances: Dhanlaxmi Bank, over the past five years, has averaged net NPA to advances ratio of 0.9%, which is on the lower side. The rating assigned is 6.

Capital adequacy ratio (CAR): Dhanlaxmi Bank's average CAR has been around 11.6% over the past five years. With the upcoming equity dilution in FY12/FY13, the CAR is expect to rise to an even more comfortable level of above 14%. The rating assigned is 6.

Considering the above analysis, the total ranking assigned to Dhanlaxmi Bank is 53, which on a weighted basis, stands at 5.2. This makes the stock a medium-risk investment from a long-term perspective. Investors however need to understand that small-caps as a category is high risk on an overall basis.

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Risk Matrix

Rating accorded

Rating Weightage* (A) Rating# (B) Weighted (A*B)

Sector risk Medium

Company's standing Medium

Performance parameters

Revenue (US$ m) 5.0% 7 0.4

Advance growth (%) 10.0% 5 0.5

Net interest margins (%) 10.0% 5 0.5

Long term EPS growth (%) 5.0% 7 0.4

Return on equity (%) 10.0% 4 0.4

Technical parameters

Dividend payout (%) 5.0% 5 0.3

Promoter holding (%) 5.0% - -

FII holding (%) 5.0% 2 0.1

Liquidity (Nos. '000) 10.0% 6 0.6

Safety Parameters

Net NPAs to advances (%) 15.0% 6 0.9

Capital adequacy ratio (%) 20.0% 6 1.2

Final Rating# 53 5.2

Valuations

Dhanlaxmi Bank currently trades at a multiple of just around 1.3 times its FY11 adjusted book value per share. Based on our estimated FY16 adjusted book value, the valuation stands at just around 0.8 times. This makes the stock a very attractive investment opportunity for long-term investors. We expect Dhanlaxmi to clock above industry average advance and profit growth, notwithstanding the short-term impact of a rise in interest rates. The bank's ability to leverage its long relationship with retail and corporate customers in south India will enable it to not just enhance its existing business but also penetrate into under-banked locations. Further, a reasonable return on equity, improved efficiency and negligible NPAs

are factors that make the bank resilient to endure a prolonged downturn, if any, without hurting shareholders' interest. Enhancement of capital base and improvement in cost efficiency are the further upsides to our estimates.

(Rs m) FY11UA FY12E FY13E FY14E FY15E FY16E Total revenues (Rs m) 4,121 5,852 7,894 10,066 12,585 15,386 Net profit (Rs m) 261 337 694 874 1,371 2,005 Diluted earnings per share (Rs) 3.1 4.0 8.2 10.3 16.1 23.6 Adjusted book value per share (Rs)

95.9 94.7 120.1 127.6 140.0 156.7

Price to earnings (x) 41.5 32.1 15.6 12.4 7.9 5.4 Price to adjusted book value (x) 1.3 1.3 1.1 1.0 0.9 0.8

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We recommend a 'BUY' on Dhanlaxmi Bank with a target price of Rs 265 from a 2 YEARSs perspective. This makes the stock a potential 2-bagger over this timeframe Financials at a glance

(Rs m) FY11UA FY12E FY13E FY14E FY15E FY16E

Interest income 9,064 15,089 21,531 27,575 31,756 39,002

Interest expense 6,413 11,177 15,754 19,837 22,182 27,379

Net interest income 2,651 3,912 5,777 7,738 9,574 11,622

Other income 1,470 1,940 2,117 2,328 3,011 3,763

Other expenses 3,445 4,682 6,157 7,852 9,439 11,385

Provisions and contingencies 281 660 685 891 1,069 962

Profit before tax 396 511 1,052 1,324 2,078 3,039

Tax 135 174 358 450 706 1,033

Profit after tax/(Loss) 261 337 694 874 1,371 2,005

Net profit margin (%) 2.9% 2.2% 3.2% 3.2% 4.3% 5.1%

No of shares (m) 85.1 85.1 110.1 110.1 110.1 110.1

Diluted earnings per share (Rs) 3.1 4.0 8.2 10.3 16.1 23.6

Balance Sheet

Advances 90,613 126,859 171,259 222,637 267,164 320,597

Investments 30,011 55,818 77,067 100,187 133,582 176,328

Fixed assets 1,344 1,411 1,481 1,555 1,633 1,715

Cash and balance with RBI 7,517 12,717 17,803 23,144 28,930 36,163

Balance with other banks 1,879 2,725 3,815 4,959 6,199 7,749

Other assets 11,293 383 7,164 5,310 6,657 7,813

Total assets 142,658 199,911 278,589 357,793 444,165 550,365

Net worth 8,441 8,736 14,125 14,944 16,260 18,210

Deposits 125,286 181,665 254,331 330,630 413,288 516,610

Borrowings 6,253 6,565 6,893 6,549 6,680 6,813

Other liabilities 2,678 2,945 3,240 5,670 7,938 8,732

Total liabilities 142,658 199,911 278,589 357,793 444,165 550,365

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