Should investors bet on DCB Bank?
Though the bank’s deposit profile is weak, it is showing signs of improvement. The bank’s operating efficiency can improve with business growth, and the stock valuation is attractive.
Highlights
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- Stock has underperformed amidst management change
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- Loan growth has picked up, margins to get stabilised
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- Asset quality stress contained, credit cost at lowest level
- Cost-to-income ratio seems to have peaked
The stock of DCB Bank (CMP: Rs 139; M Cap: Rs 4,366 crore; Rating: Overweight) has underperformed the broader equity benchmark year to date (YTD). While the Nifty 50 has risen 12 percent YTD, DCB Bank’s stock has delivered a mere 5 percent return during the same period.
The bank is trading much below its forward book value despite delivering an RoA (return on assets) of almost 1 percent and RoE (return on equity) of 12 percent in FY24. What explains this?
The Street had turned jittery as the term of Murli Natarajan, the CEO and MD who served the bank for 15 years, ended in April 2024. In general, it has been observed that a change in leadership is often followed by a kitchen-sinking exercise. Hence, the stock tends to underperform in the period preceding the management change/retirement.
Since Natarajan’s successor has been appointed from within the bank, the leadership change may not entail a change in business strategy. The earnings growth momentum will sustain, and return ratios are likely to improve further. This offers an investment opportunity.
First, let’s look at the key earnings drivers.
Acceleration in loan growth
With a loan book of Rs 40,900 crore, DCB Bank has established a market position in the small and medium enterprise (SME) segment, which, along with the mortgage (45 percent) segment, constitutes over 50 percent of the loan book, as on March’24.
DCB Bank’s net advances grew at a healthy pace of 19 percent YoY in FY24, albeit on a smaller base. The bank intends to double the balance sheet in the next 3-4 years, which translates to a compounded annual growth of 20-25 percent over the next 3-4 years.
The bank has adequate capital for a modest loan growth (15-16 percent). The promoter of the bank, Aga Khan Fund for Economic Development (AKFED), which holds a 14.77 percent equity stake, as of March’24, had expressed interest to infuse Rs 83 crore into DCB Bank in Dec’23.
Funding profile weak but improving
DCB’s deposits grew by 20 percent YoY in FY24, higher than the banking system’s deposit growth, albeit on a smaller base. DCB’s CASA deposit ratio, at 26 percent, remains much lower, compared to the banking system’s average.
However, we draw comfort from the fact that the bank has improved the granularity/composition of deposit base. This is evident as total deposits from the top 20 depositors reduced to 6.57 percent of total deposits in FY24, compared to 15 percent in FY18. This is encouraging as it lends stability to the bank’s resource profile.
The net interest margin (NIM) contracted in FY24 due to a sharp rise in cost of funds. According to the management, NIM is expected to stabilise at the 3.65-3.75 percent range.
Asset quality slips a bit, but credit cost at the lowest level
DCB’s asset quality dipped slightly as gross and net non-performing asset (GNPA and NNPA) ratio inched up due to higher slippages, at around 4 percent.
The bank’s overall restructured book declined marginally but is still high at Rs 1,263 crore. This amounts to 3.1 percent of advances book, as on March end, and needs to be monitored closely.
Despite the modest asset quality, credit cost (provisions/average assets) stood at 0.16 percent and was the key driver of earnings in FY24. Since credit cost is at the lowest level, it can only rise from here onwards.
Since the bank has hit a provision coverage ratio of above 77 percent, the management expects credit cost to remain in the pre-COVID range of 0.4-0.6 percent of the asset book, going forward.
Operating leverage will aid future earnings
DCB Bank’s operating cost has been on the higher side, as it invested on growth. This is reflected in the cost-to-income ratio of 64 percent and cost-to-average assets ratio of 2.68 percent in FY24. However, as the balance sheet expands, operating leverage will help reduce these two ratios to 55 percent and 2.4 percent, respectively, over next 4-5 quarters.
FY25 earnings is thus expected to receive support from the improvement in operating efficiency.
Valuation reasonable
DCB’s stock is trading at 0.7 times FY26 estimated book, which is compelling and prices in growth as well as asset quality concerns. A substantial valuation re-rating above 1 time book value is unlikely till the RoA improves above 1 percent, on a sustained basis.
However, the valuation can inch closer to one-time book as the RoA improves further, which will bring a meaningful stock upside in the near to medium term. Long-term investors should buy the stock.
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