Axis Bank: Pain not fully priced in

Asset quality concerns might have peaked, but normalcy could take some more quarters

Around this time last year, Axis Bank started the trend of quantifying loans which could  turn bad in course of time. Terming this a ‘watch list’, it was estimated at Rs 22,628 crore at the end of the December quarter.
 
As it set a trend of sorts, the Street rewarded the bank for being forthright in estimating the pain ahead. However, confidence faded in the June 2016 quarter, after it declared slippage from outside the watch list. Since then, with each passing quarter, the pessimism has risen. And, in the recently concluded December quarter, with the non-watch list pain growing over four-fold sequentially, doubts emerge on whether the bank was prudent in estimating the watch list.
 
Two points make a strong case for investors to question the bank on these. First, slippages outside of its watch list have been constantly increasing, quarter after quarter. Second, and more important, the additional pressures mainly come from loans lent prior to FY11, to the power, iron and steel, infrastructure and construction, and oil and gas sectors. Since these segments have forever been pain points, the possibility of expectations going wrong seem high.
 
Jairam Sridharan, chief financial officer at Axis Bank, partly agrees. “The watch list remains the key source of stress. So, that’s not gone wrong. But, our earlier estimate that only 60 per cent of the watch list will go bad was clearly an underestimation,” he states.
 
What probably went wrong is weakness in loan recovery. “There were some assumptions we took on resolution and asset monetisation while estimating our list. These haven’t played out in the expected manner. For a recovery cycle to start, it is important for the resolution mechanisms to take off first,” he says.
 
These factors together have erased the stock’s better performance over the S&P BSE Sensex between 2013 and early 2015 -– moving from Rs 167 to an all-time high of Rs 613 in February 2015. Returning to the latter high will not be easy in the near term. Investors would want to be convinced that the improvement is not temporary but strong enough to rise above the pressures of slower net profit growth and weakening asset quality. These pressures, in fact, started surfacing in FY12. Return ratios have taken a hit since then. Profit growth, too, has been slowing in the past few years, forcing investors to temper their expectations.
 

The inevitable comparison with ICICI Bank complicates the issue. While ICICI’s performance on asset quality and profitability charts a similar graph, the marginal reduction in its non-watch list slippage and exposure to troubled sectors such as iron and steel and power prompt investors to believe it could recover faster from the bad loan mess. ICICI Bank’s stock has done better than Axis in the past year.
 
Sridharan says the worst in terms of asset quality is well behind. “The trajectory on slippages and credit cost is towards moderation,” he asserts. “We’ve increased our provision coverage and we don’t want to carry the burden of the past as we enter FY18.”
 
In this context, if investors are willing to stomach the inevitable short-term pain, there is hope. While the bank is likely over the next two to three quarters to see higher provisioning and slippage, investors also need to credit Axis for having handled asset quality pressure in the past and emerging stronger. Beside getting into segments like asset management, securities, etc. The bank is well positioned to rebound when it is done sorting with the bad loan issue and as demand for big-ticket loans kick in. The currently expanding retail (small borrower) loan book should also support growth.
 
For now, after December quarter results, only 10 of the 48 analysts polled on Bloomberg have a ‘buy’ rating on the stock, and 19 each have a ‘sell’ or ‘hold’ rating. Their average target price (of where the stock would go) is Rs 484, a shade lower than the current Rs 488.