JP Morgan optimistic on Rekha Jhunjhunwala-led banking stock; do you own any?

According to JP Morgan, the primary attraction of the stock is its relatively stronger liability franchise versus midcap bank peer group in an environment of tight LDRs.

Also, Federal Bank’s share price has outperformed peers on a one-year basis. The stock has gained by 47.95% as compared to an upside of nearly 12% in Nifty 50 and gains of 28.3% in Nifty Bank. However, in 2023 so far, Federal Bank’s stock struggled after posting a sharp NIM decline in March 2023 quarter.

Year-to-date, Federal Bank’s share price has plunged a little over 8% as compared to its flat position in Nifty 50 and nearly 2% upside in Nifty Bank.

On Friday, Federal Bank’s stock price closed at ₹126.20 apiece down by 0.4% on NSE.

Nevertheless, Morgan in its note dated May 19th, said, “We think valuations are supportive at 1.1x FY24E P/B and 8x FY24E P/E when comparing to mid-cap peers and investors are getting paid to buy the thesis of a wider franchise build-out. Cap raise can be a clearing event providing capital for growth. Initiate at Overweight.”

While initiating its overweight stance, JP Morgan highlighted 3 key factors that will trigger the future performance of Federal Bank’s share price. These are:

1. ROA improvement:

When benchmarking Federal Bank’s ROA against major private banks, JP Morgan found that the gap (50bps+) largely comes out due to a lower risk-adjusted yield on assets and lower non-interest income. Cost of funds/opex differential is not high versus mid-tier bank peer group.

Morgan’s note said, “The bank’s thesis on ROA improvement (JPMe 5- 10bps each year) from lending in higher risk segments is credible, however, this will need tighter risk control in credit untested segments for a historically conservative regional bank. Notably, FY23 ROA at 1.25% is already the highest level seen since FY13.”

2. NIM risk factored in:

Federal Bank’s cumulative NIM improvement in FY23 has been just 15bp versus major private banks (ex HDFCB) at 70-100bps. Additionally, the bank’s EBLR book (50% of advances) gets offset against savings rate that are repo linked, implying a natural hedge.

Morgan’s note added, “If rates were to turn down in future given tail off in inflation print, FB’s ability to hold on the NIMs will be better given it didn’t enjoy the increase on the way up. Whilst Q4 decline was a shock, we think the bank should be able to hold FY23 levels with a slight upward bias on mix shift.”

3. Liability franchise is strong:

Data from JP Morgan revealed that Federal Bank’s liability franchise is amongst the best in the mid-cap bank peer group with retail deposits share (per LCR) at 76%, a low cost of funds vs. mid-cap bank peer group and controlled CD/LCR ratio at 82%/128%.

It added, “This places FB in a relatively good position to go for growth in a deposit-constrained environment. Lack of branch additions (5-year: 2% CAGR) remains a concern for medium-term growth.”

Thereby, JP Morgan said, “We model 16% EPS growth over the next three years keeping ROAs at 1.25-1.3% over F24-26E and loan growth CAGR of 15%. We have not imputed a cap raise in our numbers. The stock is trading at 1.1x FY24E P/B and 8x P/E – at a discount vs mid-cap bank peer group. Our Mar-24 DDMbased PT of Rs150 values the bank at 1.2x FY25E P/B.”

An overweight rating on a stock means that the respective share price deserves to be weighted higher than compared to the current weighting on the benchmarks. It also means that the stock has the potential for better performance going forward.

With ₹150 target price set on Federal Bank, the stock has a potential of nearly 18% upside.

Ace investor Rekha Jhunjhunwala will be among the key gainers with Federal Bank’s double-digit upside trajectory.

Rekha holds a total of 7,27,13,440 equity shares or 3.48% in Federal Bank as of March 31, 2023.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.