Shift To Average CASA And Fixed-Rate Loans Will Strengthen Future Stability

Key Takeaways

• Strategic shifts towards fixed-rate auto loans and CASA deposits are aimed at enhancing NIM and deposit quality through long-term value creation.
  
• Focus on medium and high-yield portfolios and conservative unsecured lending strategy aims for sustainable revenue growth and improved profitability.
  
• Strategic reorientation and increased provisioning might negatively affect short-term growth and profitability, while regulatory and macroeconomic challenges add pressure on margins and asset quality.

Catalysts

Provides a range of banking and financial services in India.

• The strategic reorientation towards improving the quality of the bank's liability base, focusing on average CASA rather than EOP metrics, is expected to stabilize and improve deposit quality. This shift aims to sustain growth in NIM by focusing on long-term value creation from deposits rather than short-term fluctuations.
  
• The bank's deliberate decision to pivot towards fixed-rate auto loans from a floating-rate model is anticipated to improve NIM in the medium term. Transitioning a significant portion of disbursements to fixed rates may enhance interest income predictability and medium-term profitability.
  
• An increase in the bank's medium and high-yield business portfolios, such as commercial banking, business banking, and gold loans, along with a focus on enhancing pricing in these segments, is likely to support a healthier revenue growth trajectory as these areas typically exhibit robust margins.
  
• Federal Bank's recalibration of its unsecured lending strategy through conservative growth, particularly in the MFI sector while strategically maintaining credit card business growth, reflects a move towards responsible and sustainable revenue generation with a focus on quality yield.
  
• The introduction of more robust provisioning norms aligns with industry best practices, aiming to mitigate potential credit risks and ensure future earnings stability by aligning operational risks with timely financial recognition, potentially resulting in improved profitability in the long run.

Federal Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Federal Bank's revenue will grow by 14.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 30.5% today to 31.5% in 3 years time.
• Analysts expect earnings to reach ₹63.0 billion (and earnings per share of ₹25.67) by about January 2028, up from ₹40.4 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 12.7x on those 2028 earnings, up from 11.3x today. This future PE is greater than the current PE for the GB Banks industry at 9.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.22%, as per the Simply Wall St company report.

Federal Bank Future Earnings Per Share Growth

Risks

• The strategic reorientation of the bank's deposit and loan portfolio might temporarily deter growth as the bank focuses on building a sustainable deposit base. This reorientation could impact short-term revenue and loan growth.
  
• The new provisions system, which accelerates provisioning against NPAs, has impacted profitability this quarter. While intended to align with industry best practices, this could continue impacting earnings as the bank adjusts to these changes.
  
• The pressure on margins is evident as deposit costs have increased despite efforts to improve the liability composition. This could dilute net interest margins (NIM) if cost reductions in deposits do not materialize as expected.
  
• Regulatory headwinds in the gold loan segment and stress in the microfinance portfolio could impact asset quality and contribute to credit costs, potentially affecting future net margins and earnings stability.
  
• The current macroeconomic environment poses uncertainty, with sensitivity to interest rate movements affecting both asset and liability sides. A falling rate scenario without adequate hedging or diversification could pressure NIM and overall financial performance.

Valuation

• The analysts have a consensus price target of ₹219.59 for Federal Bank based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹260.0, and the most bearish reporting a price target of just ₹170.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹199.9 billion, earnings will come to ₹63.0 billion, and it would be trading on a PE ratio of 12.7x, assuming you use a discount rate of 14.2%.
  
• Given the current share price of ₹186.18, the analyst's price target of ₹219.59 is 15.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.