ANNUAL REPORT ANALYSIS

AXIS Retail earnings soft; power recognition underway

India Equity Research| Banking and

Analysis of ’s FY18 annual report provides incremental insights into EDELWEISS 4D RATINGS sector-wise stress accretion (power sector GNPL stood at 4.3% and iron & Absolute Rating HOLD steel at >60%). Dismal asset quality (multi-fold rise in slippages due to stress Rating Relative to Sector Underperform up-fronting while maintaining provision coverage) and lower treasury profits Risk Rating Relative to Sector Medium took the sheen off FY18 earnings momentum. Even retail earnings were Sector Relative to Market Overweight subdued (PBT fell 44% YoY) on soft NII (impact of transfer pricing) and higher provisions. Subsidiaries however gained momentum with revenue/earnings up 31%/5%. Going ahead, returns profile is expected to be modest as: a) >2% MARKET DATA (R: AXBK.BO, B: AXSB IN) of book in still unrecognised stress; b) resolutions are slower; and c) NIMs CMP : INR 543 are at lower levels (settling at 3.4%). Maintain ‘HOLD’. Target Price : INR 535 52-week range (INR) : 628 / 448 Share in issue (mn) : 2,567.7 Further stress recognition in power a key monitorable M cap (INR bn/USD mn) : 1,395 / 20,633 Within power sector, 4.3% GNPLs was recognised as stress. This compares with 25-30% Avg. Daily Vol.BSE/NSE(‘000) : 8,381.6 power sector GNPLs for peer (SBI and ). Moroever, 64% of power exposure is still rated ‘BBB and below’ that increases probability of further recognition. Post SHARE HOLDING PATTERN (%) the RBI’s reclassification while SDR has devloved the bank still has 5.25 of INR7bn (0.2% of Current Q3FY18 Q2FY18 book) and S4A of INR5bn (five accounts, 0.1% of book). Promoters * 26.4 26.7 28.6

MF's, FI's & BK’s 12.8 13.8 9.1 Retail earnings also tepid FII's 47.7 45.5 46.3 Segment-wise profitability analysis suggests that FY18 earnings were marred by corporate Others 13.2 14.1 16.0 portfolio (PBT loss of INR59bn) due to higher stress upfronting. Even as retail cushioned * Promoters pledged shares : NIL overall earnings, it was low (PBT fell 44%) due to: a) softer NII (flat YoY); b) higher opex (up (% of share in issue)

>17% YoY, 70% of overall opex); and c) higher provisions (up 120% YoY). PRICE PERFORMANCE (%)

Focus to build retail franchise continued EW Banks and Stock Nifty Financial The bank’s retail franchise continues to strenghten with: a) 23% loan growth now forming Services Index 47% of loans. Impressively, existing deposit customers contributed ~72% of incremental retail 1 month 4.7 (1.2) 2.8 loans, reflecting strong cross-sell franchise; b) >13% of growth in retail deposits with SA+ 3 months 2.4 1.2 4.0 retail TD now stands at >84%; and c) sustained core fee growth of 22% (forms 48% of fee). 12 months 5.3 10.3 11.5

Outlook and valuation: Weak earnings profile; maintain ‘HOLD’ Even as retail continues to strengthen, earnings visibility remains weak. FY18 performance has rattled investors’ confidence. This, along with uncertainty at top management level, will cap valuation in near to medium term. We expect valuations to be capped at 2x FY20E Kunal Shah P/BV for RoE of sub-15% (post capital) levels. Maintain ‘HOLD/SU’. +91 22 4040 7579

Financials (INRmn) [email protected] Year to March FY17 FY18 FY19E FY20E Prakhar Agarwal Net revenue 297,844 295,848 364,207 428,927 +91 22 6620 3076 Net profit 36,793 2,757 78,853 107,538 [email protected] Diluted EPS (INR) 15.4 1.1 30.2 41.2 Abhishek Agrawal Adj. BV (INR) 207.6 201.9 232.5 269.5 +91 22 4040 7402 Price/ Adj book (x) 2.6 2.7 2.3 2.0 [email protected]

Diluted P/E (x) 35.3 505.5 18.0 13.2

ROE (%) 6.8 0.5 11.7 14.3 May 31, 2018 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited Banking and Financial Services

Another year of higher stress, power sector slippages to rise FY18 marked yet another year of higher stress recognition for the bank (slippages rose to 3.2%), leading to higher credit cost (3.6% vs. average of 1.1% in earlier cycle) in turn aggravating losses in corporate portfolio. Few key takeaways about asset quality:

 Sector-wise GNPLs indicate 4.3% in power was recognised as stress. This compares with 25-30% power sector stress for peer banks (viz. SBI, BoB). Moroever, 64% of the power exposure is still rated ‘BBB and below’ which increases probability of further recognition. Coverage in this segment continues to be relatively lower (43%), which on resolution if it calls for higher haircut suggests elevated credit cost.  Post RBI reclassification while SDR has devolved, the bank still has 5.25 of INR7bn (0.2% of book) and S4A of INR5bn (five accounts, 0.1% of book).

 The bank reported divergence of INR56.3bn (pertaining to RBI’s risk-based supervision for FY17). Having said that, the bank has taken into account entire impact of the divergence in FY18 and there are no follow ups anticipated.

 Overseas GNPLs fell to INR43bn (INR47bn in FY17).  Share of the top-4 NPLs came off to 15.6% levels from 23.4% in FY17. Moreover, share of sub-standard loans declined to 23% of NPLs from 27% in FY17 with rise in the doubtful bucket (70% versus 48% in FY17) given slippages from earlier restructured and other potential stress assets (viz. SDR/S4A etc).

We anticipate another soft year - FY19 for the bank in terms of slippages and credit cost. We are building in slippages of 3.2% and credit cost of 2% for FY19, which will restrict earnings.

Table 1: Iron & Steel, infra & services major source of stress in FY18; recognition in power still low vs. peers which increases probability of further recognition GNPLs Recognised (INR bn) Coverage (%) FY17 FY18 Increase % contribution stress (%) Iron & Steel 41.0 86.1 45.1 34.7 62.6 43.8 Infrastructure (excluding power) 29.3 47.9 18.6 14.3 11.2 47.5 Professional services 16.9 34.8 17.9 13.7 60.9 49.6 Commercial real estate 10.9 19.0 8.1 6.2 10.5 50.9 Engineering 10.5 13.9 3.4 2.6 4.8 63.4 Power generation & distribution 6.3 9.8 3.5 2.7 4.3 42.7 Trade 6.0 9.1 3.1 2.4 3.4 53.7 Chemicals and chemical products 4.1 8.6 4.5 3.5 3.0 52.8 Food processing 3.6 6.9 3.3 2.5 6.6 65.3 Banking and finance 1.9 1.3 -0.6 -0.5 0.2 60.0 Petroleum coal and nuclear fuels 1.2 2.0 0.8 0.6 2.0 71.9 Metal and metal products 0.8 1.6 0.8 0.6 1.2 40.9 Construction 0.8 1.6 0.8 0.6 2.0 94.6 Retail, agri & other Industries 79.4 100.2 20.8 16.0 3.9 55.3 Total 212.8 342.9 130.1 100.0 4.4 50.8 Stress recognition in power still below peers. Also, 64% of portfolio is BBB rated and below, which increases probability of further recognition

2 Edelweiss Securities Limited Axis Bank

Table 2: Post RBI reclassification norms, other potential stress restricted to 0.3% … Weighted average duration in 5:25 accounts changed to 19 (INR mn) 5/25 refinancing S4A SDR Other potential stress years versus 10 years earlier No. of accounts 3 5 Nil 8 Amount O/s 9,725 11,338 Nil 21,063 -Standard 6,822 4,862 Nil 11,684 For accounts under S4A, PART A loans comprises 58% of loans (%) of loans 0.2 0.1 Nil 0.3

Chart 1: …thus vulnerable pool in non-NPA book down to 2.1% of loans

657 9.0% 526 5.6% 394 (%) 263 2.1% 131

0 FY16 FY17 FY18 BB & Below Watch List Corp. Restructures SDR / S4A / 5-25

Chart 2: Stress up-fronting fed into higher credit cost with coverage maintained

5.0 90.0

4.0 3.6 76.8 2.8 3.0 63.6 2.3 (%) (%) 2.0 50.4 1.4 1.0 1.1 0.7 1.0 0.5 0.6 0.5 0.6 0.6 0.6 37.2 0.0 0.2 0.0 24.0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 Credit cost Coverage (RHS)

Exposure to top-4 NPLs increased in absolute terms Table 3: Overseas NPLs decline both in absolute and percentage terms

Stress in overseas book coming (INR mn) FY15FY16FY17FY18 off Exposure of top 4 NPLs 9,313 11,211 49,839 53,401 (%) of GNPLs 22.7 18.4 23.4 15.6 Overseas NPLs 2,652 9,034 46,952 43,110 (%) of GNPLs 6.5 14.8 22.1 12.6 Source: Company, Edelweiss research

3 Edelweiss Securities Limited Banking and Financial Services

Table 4: Reported divergence of 1.5% fully accounted for in FY18 Divergence (INR bn) FY16 FY17 GNPL (reported) 60.9 212.8 GNPL as accessed by RBI 155.7 269.1 Divergence in GNPL 94.8 56.3 Quantum of reported divergence is coming off. The Divergence as (%) of loans 2.8 1.5 divergence comprised nine NNPL (reported) 25.2 86.3 accounts (one steel, three power, one IT/ITES, among NNPL as accessed by RBI 96.9 129.4 other four) Divergence in NNPL 71.6 43.2 Provision for NPL (reported) 33.9 122.1 Provision for NPL as accessed by RBI 57.1 135.2 Divergence in provisioning 23.1 13.2 Reported PAT 82.2 36.8 Adjusted PAT 66.9 27.9

Table 5: Despite recognition, earlier restructuring did not lead to any major change in seasoning bucket (INR bn) FY15 FY16 FY17 FY18 Sub-standard 10,584 16,139 58,394 79,304 Doubtful 15,377 30,838 1,01,330 2,39,420 -Doubtful 1 8,968 13,066 54,569 1,18,119 -Doubtful 2 5,958 17,206 42,045 98,254 -Doubtful 3 451 566 4,716 23,047 Loss 15,141 13,898 53,081 24,146 Total 41,102 60,875 2,12,805 3,42,870 (%) FY15 FY16 FY17 FY18 Sub-standard 25.8 26.5 27.4 23.1

There has been rise in Doubtful Doubtful 37.4 50.7 47.6 69.8 categories which now form 70% -Doubtful 1 21.8 21.5 25.6 34.5 versus 48% in FY17. Large part of rise is attributable to -Doubtful 2 14.5 28.3 19.8 28.7 slippages from restructured and -Doubtful 3 1.1 0.9 2.2 6.7 other stressed pool (viz. SDR/S4A etc) Loss 36.8 22.8 24.9 7.0 Source: Company

Retail earnings soft, corporate hit by credit cost FY18 earnings were impacted by corporate segment (PBT loss of INR59bn), led by higher asset quality stress percolating into weak revenue growth. While retail cushioned earnings, it was still soft (PBT down 44%) due to: a) soft NII (flat YoY, impact of transfer pricing); b) higher opex (up >17% YoY, 70% of overall opex) and c) higher provisions (up 120% YoY). Treasury delivered 8% YoY PBT growth also benefitting from transfer pricing.

 Retail: Reported PBT of INR20bn ( down 44% YoY) on: a) softer growth in NII (flat YoY), largely due to impact of transfer pricing mechanism, excluding which for external customers grew strong >60% YoY; b) sustained higher opex growth (up > 17% YoY, 70% of overall opex), given sustained branch expansion; and c) higher provisions (up 120% YoY).

4 Edelweiss Securities Limited Axis Bank

 Corporate: Reported PBT loss of INR59bn on higher asset quality stress, which not only reflected in higher credit cost (up >18% YoY) but also led to weak revenue profile (NII down >19% YoY) on higher interest income reversal, even as loan growth was >10% YoY.

 Treasury: Reported PBT of INR31bn ( up 8% YoY) . The performance appears to be more driven by NII from internal transfer mechansim than from treasury book.

Table 6: Corporate segment continues to report loss, retail segment profitability impacted by lower NII and higher provisions Retail Corporate TreasuryOthers Total (INR bn) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 NII 76 97 96 78 85 68 14 (1) 21 (0) (0) (0) 168 181 186 Non-Interest Income 27 31 40 33 30 28 25 46 31 9 10 11 94 117 110 Net revenue 103 127 136 111 115 97 39 45 52 9 10 11 262 298 296 Operating expenses 71 83 98 25 33 37 4 5 4 1 1 1 101 122 140 Operating profit 33 44 39 86 82 59 35 41 48 8 9 10 161 176 156 Provisions 5 8 19 30 100 119 2 12 18 0 0 0 37 121 155 PBT 27362056(19)(59)3329318910124551 Growth (%) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 NII 28.3 26.6 (0.4) 11.3 8.7 (19.7) 10.6 (106.8) NA NA 314.3 0.0 18.3 7.5 2.9 Non-Interest Income 25.4 14.5 29.2 4.9 (9.1) (5.0) 13.0 83.9 (33.5) 2.2 12.0 7.5 12.0 24.8 (6.2) Opex 9.3 17.5 17.4 11.8 31.2 12.5 1.4 16.8 (16.0) 26.6 8.0 3.4 9.7 20.8 14.7 Operating profit 99.5 36.4 (13.1) 8.7 (4.7) (27.4) 13.4 17.1 18.5 (0.5) 12.5 8.1 20.3 9.2 (11.3) Provisions 13.0 63.6 121.1 61.7 234.1 18.0 1,321.2 549.9 42.6 NA NA NA 59.3 226.6 27.7 PBT 132.9 31.3 (44.4) (7.7) (133.7) 215.8 7.7 (13.5) 8.1 (0.4) 12.5 8.1 12.1 (55.9) (97.8) Proportion (%) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 NII 45.3 53.4 51.7 46.6 47.1 36.8 8.1 (0.5) 11.5 (0.0) (0.0) (0.0) 100.0 100.0 100.0 Non-Interest Income 28.8 26.4 36.4 34.7 25.3 25.6 26.9 39.7 28.2 9.5 8.6 9.8 100.0 100.0 100.0 Opex 70.0 68.1 69.7 25.0 27.2 26.7 3.9 3.7 2.7 1.1 1.0 0.9 100.0 100.0 100.0 Operating profit 20.2 25.3 24.8 53.2 46.4 38.0 21.7 23.3 31.1 4.9 5.0 6.1 100.0 100.0 100.0 Provisions 13.9 6.9 12.0 81.0 82.9 76.6 5.1 10.2 11.4 0.0 0.0 0.0 100.0 100.0 100.0 PBT 22.1 65.9 NA 44.9 (34.3) NA 26.7 52.3 NA 6.3 16.2 NA 100.0 100.0 100.0

Retail segment continues to be high on opex, comprising 70% of overall opex largely following continued branch expansion

Table 7: NII of retail segment impacted by transfer pricing, growth in external customer NII still strong at 60% levels Retail Corporate TreasuryOthers Total (INR bn) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 Interest income 145 171 193 153 158 146 112 117 118 0 0 0 410 445 458 Interest expense 121 133 130 5 7 8 116 125 133 0 0 0 242 264 272 NII (external customers) 24 38 63 148 151 138 (3.8) (8.3) (14.8) 0 0 0 168 181 186 Inter segment interest income 168 180 173 48 54 54 465 487 494 0 0 0 681 721 721 Inter segment interest expense 116 122 140 117 119 124 447 480 458 0 0 0 681 721 721 NII (Internal customers) 52 58 33 (69) (66) (70) 17 7 36 (0) (0) (0) 0 0 0 Growth (%) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 NII (external customers) 55.4 56.2 64.9 10.7 2.3 (8.7) (44.9) 119.7 78.0 NA NA NA 18.3 7.5 2.9 NII (Internal customers) 18.5 12.7 (43.1) 10.0 (5.0) 5.6 (9.3) (57.6) 390.7 NA 314.3 NA NA NA NA NII (overall) 28.3 26.6 (0.4) 11.3 8.7 (19.7) 10.6 (106.8) NA NA 314.3 NA 18.3 7.5 2.9 Source: Company, Edelweiss research

5 Edelweiss Securities Limited Banking and Financial Services

Continued expansion plan keeps retail opex high As highlighted in the earlier section, the bank continued to grow its retail franchise (branch expansion and building teams across product segments, among others). This kept opex high (up >17% YoY), forming 70% of overall opex. On the other hand, cost benefits percolated into corporate (up <13% YoY) and treasury (down 16% YoY) segments, which restricted overall opex growth to 14%.

Table 8: Retail continues to run on higher opex on continued expansion, lower costs in treasury limits overall costs Retail Corporate Treasury Others Total (INR bn) FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 Operating expenses 71 83 98 25 33 37 4 5 4 1 1 1 101 122 140 growth 9.3 17.5 17.4 11.8 31.2 12.5 1.4 16.8 (16.0) 26.6 8.0 3.4 9.7 20.8 14.7 Branch 2,904 3,304 3,703 growth 12.2 13.8 12.1 Average cost/branch 24.4 25.1 26.3 Source: Company

Table 9: Branch opening tilted towards semi-urban/rural areas, with focus on improving branch density and thus productivity (%) FY17 FY18 5-10 Branch per location Branches (Nos.) 3,304 3,703 branch >10 branch Metro 31 30 1% 2% 2-4 branch Urban 24 23 8% Semi-Urban 29 30 Rural 16 17

1 branch 89%

Source: Company

Retail franchise continues to strengthen The bank’s retail franchise continued to strenghten as reflected in: a) 23% loan growth, now forming 47% of loans with 84% being secured. Impressively, ~50% of incremental retail loans were sourced through branches, while existing deposit customers contributed ~72% of the incremental retail loans, reflecting strong cross sell franchise; b) >13% of growth in retail deposits with SA+ retail TD now stands at >84% following sustained branch addition (399 branches in FY18); and c) sustained core fee growth of 22% (contribution stood higher at 48%).

6 Edelweiss Securities Limited Axis Bank

Table 10: Retail assets maintain momentum with >20% growth; forms 47% of loans (INR bn) FY15FY16FY17FY18 Retail 1,119 1,385 1,680 2,065 (%) of advances 40 41 45 47 Impressively, 72% of Unsecured (%) 13141516 contribution to retail loans driven by existing retail deposit -PL & CC (%) 9 11 12 14 Incr. sourcing through branches (%) 40 50 50 50 Existing deposit customer contribution to 66 66 66 72 retail loans (%) Source: Company

Table 11: Retail deposits maintain momentum, now form > 84% of deposits FY15 FY16 FY17 FY18 Deposits 3,224 3,580 4,144 4,536 Retail deposits 2,510 2,914 3,370 3,816 -CA 561 637 870 957 -SA 883 1,058 1,260 1,482 -Retail TD 1,066 1,220 1,239 1,378 Growth FY15 FY16 FY17 FY18 Deposits 14.8 11.0 15.8 9.5 Retail deposits 19.1 16.1 15.6 13.3 -CA 15.2 13.4 36.7 9.9 -SA 13.5 19.8 19.1 17.6 -Retail TD 26.5 14.4 1.6 11.2 Proportion FY15 FY16 FY17 FY18 Deposits 100.0 100.0 100.0 100.0 Retail deposits 77.8 81.4 81.3 84.1 -CA 17.4 17.8 21.0 21.1 -SA 27.4 29.6 30.4 32.7 -Retail TD 33.1 34.1 29.9 30.4 Source: Company

Fee growth supported by retail, mutual fund distribution Overall non-interest income fell >6% YoY, largely led by lower treasury profits (down >33% YoY, 28% of overall non-interest income) and lower corporate fees (down >5% YoY, 26% of overall non-interest income). On the other hand, retail fees sustained momentum, registering strong >22% YoY growth. Interestingly, distribution income from life insurance declined by >3% YoY, this was despite the >20% Individual APE growth in Max Financial Services – a trend that needs to be tracked. Meanwhile, distribution income from mutual funds sustained, registering >22% YoY growth.

7 Edelweiss Securities Limited Banking and Financial Services

Table 12: Retail fee extends growth, now forms 48% of fees FY15 FY16 FY17 FY18 Retail fees 26,030 30,270 34,810 42,570 -growth 29.6 16.3 15.0 22.3

Growth largely supported by Share of retail fees (%) 38.0 40.0 44.0 48.0 steady growth in card fees Composition (%) FY15 FY16 FY17 FY18 overtime -Cards 29.0 34.0 36.0 38.0 -Distribution (MF & Ins) 33.0 29.0 29.0 25.0 -Others 38.0 37.0 35.0 37.0 Source: Company

Table 13: Some softness in growth seen in life insurance distribution fees Bancassurance (INR mn) FY15 FY16 FY17 FY18 Life insurance 4,913 4,982 5,582 5,395 Non-life insurance 224 234 330 564 Mutual fund 3,144 3,114 3,174 3,885 Others 342 571 886 885 Total 8,623 8,901 9,972 10,728 Growth (%) FY15 FY16 FY17 FY18 Growth softness seen, despite Life insurance 5.0 1.4 12.1 (3.4) better growth momentum in Non-life insurance 23.3 4.2 41.1 71.2 partner, Max Financial Services Mutual fund 110.4 (1.0) 1.9 22.4 Others 30.1 67.0 55.1 (0.1) Total 30.3 3.2 12.0 7.6 Proportion (%) FY15 FY16 FY17 FY18 Life insurance 57.0 56.0 56.0 50.3 Non-life insurance 2.6 2.6 3.3 5.3 Mutual fund 36.5 35.0 31.8 36.2 Others 4.0 6.4 8.9 8.2 Total 100.0 100.0 100.0 100.0 Source: Company

Tilt towards better rated corporate, off-balance sheet coming off In its bid to move towards quality, the bank is focusing on better rated corporates –to elucidate ~86% of new sanctions in the corporate book were to companies rated ‘A’ and above and 77% of outstanding standard corporate loans were to companies rated ‘A’ and above. The move towards lower risk assets is also reflected in lower RWA/asset which declined from 81% in FY17 to 77% in FY18. In terms of the off-balance sheet exposure too there has been consistent decline as overall contingent liabilities to asset declined to 106% (from 111% in FY17) with drop across derivatives, guarantees and acceptences. The credit equivalent amount (CEA) proportion also fell to 15.5% (17.4% in FY17).

8 Edelweiss Securities Limited Axis Bank

Chart 3: Move towards better rated corporate continued, reflected in >85% of sanctions being A- & above rated; on outstanding basis too A & above rated portfolio grew to 77% (68% in FY17)

104.0 100 10 5 18 94.0 80 22 85 86 81 30 84.0 79 79 60 31

74 (%) 74.0 40 68 34 25 64.0 20 12 13 54.0 0 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY17 FY18 (%) of sanctions rated A- & above AAA AA A BBB BB or below

Source: Company, Edelweiss research

Table 14: Off-balance sheet exposures coming off gradually with decline in derivatives, guarantees and acceptances Contingent Liability breakup (INR bn) Contingent Liability as a % of Assets Total CL Derivatives Guarantees Acceptances Others Assets Total CL Derivatives Total-Non Guarantees Acceptances Others Networth (A+B+C+D) (A) (B) (C) (D) (INR bn) derivatives (E) (F) (G)CL as % of NW (INR bn) (E+F+G) 2018 7,353 5,702 850 324 477 6,913 106.4 82.5 23.9 12.3 4.7 6.9 1,159 634 2017 6,696 5,187 811 335 363 6,015 111.3 86.2 25.1 13.5 5.6 6.0 1,201 558 2016 6,174 4,782 687 295 411 5,255 117.5 91.0 26.5 13.1 5.6 7.8 1,161 532 2015 5,912 4,681 721 316 194 4,619 128.0 101.3 26.6 15.6 6.8 4.2 1,323 447

Conv. of CL to credit equivalent amount (CEA) (INR bn) CEA as a % of assets CCF on Total-Non Total CL Derivatives Guarantees Acceptances Others Derivatives Total CL Derivatives derivatives Guarantees Acceptances Others Networth (A+B+C+D) (A) (B) (C) (D) (%) (E+F+G) (E) (F) (G)CL as % of NW (INR bn) 2018 1,071 225 637 113 95 4.0 15.5 3.3 12.2 9.2 1.6 1.4 169 634 2017 1,045 246 608 117 73 4.8 17.4 4.1 13.3 10.1 2.0 1.2 187 558 2016 880 180 515 103 82 3.8 16.7 3.4 13.3 9.8 2.0 1.6 166 532 2015 860 170 541 111 39 3.6 18.6 3.7 14.9 11.7 2.4 0.8 193 447 Source: Company, Edelweiss research

9 Edelweiss Securities Limited Banking and Financial Services

Table 15: Growth in credit risk RWA at sub-10% levels; RWA/asset falls to 77% (INR bn) FY15 FY16 FY17 FY18 RWA 3,531 4,125 4,848 5,341 -Credit 2,981 3,459 4,065 4,462 -Market 279 301 351 388 -Operational 270 365 432 492 Asset 4,619 5,255 6,015 6,913 RWA/Asset (%) 76.4 78.5 80.6 77.3 Loans 2,811 3,388 3,731 4,397 Credit RWA/Loans (%) 106.1 102.1 109.0 101.5 Growth (%) FY15 FY16 FY17 FY18 RWA 22.7 16.8 17.5 10.2 -Credit 21.5 16.0 17.5 9.8 Credit RWA growth at sub-10% levels, with RWA growth -Market 37.4 8.0 16.5 10.4 largely driven by operational -Operational 21.6 35.2 18.2 13.9 Asset 20.5 13.8 14.5 14.9 Loans 22.2 20.5 10.1 17.8 Source: Company

Four-pronged strategy to drive FY19 FY18 was a tumultuous year for the bank, reflected in muted earnings growth momentum (RoE of sub-1% levels). Stepping into FY19, the bank has chalked out four-pronged strategy a) aims to achieve normalisation of credit risk with sustained movement of corporate business towards better rated corporate (currently 77% of standard corporate book is A and above rated) and working capital loans; b) focus would be on delivering profitable growth; c) enhance capabilities to strengthen operational risk management and re-invent corporate bank, driven by technology; and d) continue investing in digital capabilities, analytics and bank’s subsidiaries to drive future growth.

Fig .1: Four pronged strategy going forward for FY19 1 Normalize Credit Risk 2 Deliver Profitable Growth

Continue shaping business mix in corporate Grow loans and CASA faster than industry loan book by moving towards better rated Prioritise growth in segments with better customers and working capital loans risk adjusted returns Achieve cost efficiencies

3 Enhance Capabilities 4 Invest in the Future

Heighten focus on operational risk Continue investment in digital and analytics management and compliance Scale up subsidiaries and fill white spaces Reinvent the corporate bank

Source: Company

10 Edelweiss Securities Limited Axis Bank

Subsidiaries: Improvement continues During FY18, the bank’s subsidiaries sustained their improving trend reporting revenue and earnings growth of 31% and 5%, respectively.  Axis Capital: Provides services pertaining to investment banking, equity capital markets, institutional stock broking, mergers and acquisition advisory, etc. It enjoys 42% share of the IPO market. In FY18, Axis Capital contributed 29% to total earnings of the subsidiaries.

 Axis Finance: An NBFC that carries on activities of loans against shares, margin funding, IPO financing, etc. For FY18, it reported loan growth of 54%, driven by 64% growth in retail loans. Axis Finance’s earnings increased by 27% YoY and contributed 44% to total earnings of subsidiaries.  Axis AMC: Reported 45% YoY growth in average AUM with 26% growth in total number of folios and contributed 9% to total earnings of subsidiaries.

 Axis Securities: The entity is primarily in the business of marketing credit cards and retail asset products. It also provides retail broking services. It continues to contribute to the bank’s retail franchise building and customer service. For FY18, reported 33% growth in cumulative client base to 1.84mn and contributed 13% to total earnings of subsidiaries. Table 16: Traction in subsidiaries continued; Axis Finance and Axis Capital posted good performance Dividend Total asset Turn over Profit INR mn (%) holding FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 Axis Capital 100.0 - 1,418 11,988 13,613 3,437 4,345 1,132 1,388 Axis Private Equity 100.0 - - 42 40 2 2 (3) (3) Axis Trustee Services 100.0 149 163 673 729 362 384 172 202 Axis AMC 75.0 - - 3,739 5,045 5,310 7,525 570 430 Axis Finance Ltd 100.0 - 1,460 52,756 66,765 5,754 7,215 1,653 2,094 Axis Securities Ltd 100.0 - 235 4,484 5,367 7,561 9,505 515 604 FreeCharge 100.0 - - - 1,497 - 195 - (281) Source: Company

11 Edelweiss Securities Limited Banking and Financial Services

Company Description Axis Bank is the third-largest private sector bank in in terms of asset size, with a balance sheet of >INR6.4tn. It has a network of over 3,703 branches and extension counters across the country. The bank earns substantial fee income from transaction and merchant banking activities.

Investment Theme Even as retail continues to strengthen, earnings visibility remains weak. FY18 performance has rattled investors’ confidence. This, along with uncertainty at top management level, will cap valuation in near to medium term. We expect valuations to be capped at 2x FY20E P/BV for RoE of sub-15% (post capital) levels. Maintain ‘HOLD/SU’.

Key Risks Deterioration of macro environment can result in higher slippages and slow down business growth.

In the event of demand for credit dying down as in the current scenario, lack of pricing power can impact its margins adversely.

12 Edelweiss Securities Limited Axis Bank

Financial Statements Key Assumptions Income statement (INR mn) Year to March FY17 FY18 FY19E FY20E Year to March FY17 FY18 FY19E FY20E Macro Interest income 445,422 457,803 528,931 600,886 GDP(Y-o-Y %) 6.6 6.5 7.1 7.6 Interest expended 264,490 271,626 303,264 328,249 Inflation (Avg) 4.5 3.6 4.5 5.0 Net interest income 180,931 186,177 225,668 272,636 Repo rate (exit rate) 6.3 6.0 6.0 6.5 Non interest income 116,913 109,671 138,540 156,290 USD/INR (Avg) 67.1 64.5 66.0 66.0 - Fee & forex income 78,804 88,671 101,390 115,938 Sector - Misc. income 4,108 4,830 9,150 12,352 Credit growth 9.0 12.0 14.0 17.0 - Investment profits 34,002 16,170 28,000 28,000 Deposit growth 14.0 12.0 13.0 14.0 Net revenue 297,844 295,848 364,207 428,927 CRR 4.0 4.0 4.0 4.0 Operating expense 121,999 139,903 159,681 181,457 SLR 20.0 20.0 19.5 19.0 - Employee exp 38,919 43,130 49,168 55,192 G-sec yield 6.5 6.5 7.0 7.1 - Other opex 83,081 96,774 110,513 126,266 Company Preprovision profit 175,845 155,945 204,526 247,470 Op. metric assump. (%) Provisions 121,170 154,728 88,565 89,324 Yield on advances 9.3 8.4 8.4 8.0 Loan loss provisions 107,192 163,080 87,565 88,324 Yield on investments 7.7 7.1 6.7 6.4 Investment depreciation 2,390 (2,110) - - Yield on asset 8.5 7.7 7.6 7.3 Other provisions 11,588 (6,242) 1,000 1,000 Cost of funds 5.2 4.6 4.4 4.1 Profit Before Tax 54,676 1,217 115,961 158,145 Net interest margins 3.5 3.1 3.3 3.3 Less: Provision for Tax 17,883 (1,540) 37,108 50,607 Cost of deposits 5.0 4.4 4.2 3.8 Profit After Tax 36,793 2,757 78,853 107,538 Cost of borrowings 7.0 6.5 6.1 5.9 Shares o /s (mn) 2,395 2,567 2,612 2,612 Spread 3.3 3.1 3.2 3.3 Adj. Diluted EPS (INR) 15.4 1.1 30.2 41.2 Tax rate (%) 32.7 (126.6) 32.0 32.0 Dividend per share (DPS) 5.0 - 8.0 8.0 Balance sheet assumption (%) Dividend Payout Ratio(%) 35.9 - 29.2 21.4 Credit growth 10.5 18.1 19.9 20.0 Deposit growth 15.8 9.5 21.1 21.8 Growth ratios (%) SLR ratio 17.9 18.5 18.0 17.5 Year to March FY17 FY18 FY19E FY20E Low-cost deposits 51.4 53.8 53.4 54.2 NII growth 7.5 2.9 21.2 20.8 Gross NPA ratio 5.3 7.1 6.0 5.2 Fees growth (1.3) 12.5 14.3 14.3 Net NPA ratio 2.3 3.8 2.7 2.0 Opex growth 20.8 14.7 14.1 13.6 Net NPA / Equity 15.5 26.2 20.6 16.2 PPOP growth (5.9) (1.5) 26.3 24.3 Capital adequacy 14.9 17.4 16.9 16.6 PPP growth 9.2 (11.3) 31.2 21.0 Incremental slippage 6.0 8.3 3.2 3.0 Provisions growth 226.6 27.7 (42.8) 0.9 Provision coverage 59.5 51.6 58.0 64.7 Adjusted Profit (55.3) (92.5) 2,760.2 36.4

Operating ratios Year to March FY17 FY18 FY19E FY20E Yield on advances 9.3 8.4 8.4 8.0 Yield on investments 7.7 7.1 6.7 6.4 Yield on assets 8.5 7.7 7.6 7.3 Cost of funds 5.2 4.6 4.4 4.1 Net interest margins 3.5 3.1 3.3 3.3 Cost of deposits 5.0 4.4 4.2 3.8 Cost of borrowings 7.0 6.5 6.1 5.9 Spread 3.3 3.1 3.2 3.3 Cost-income 41.0 47.3 43.8 42.3 Tax rate 32.7 (126.6) 32.0 32.0

13 Edelweiss Securities Limited Banking and Financial Services

Balance sheet (INR mn) RoE decomposition (%) As on 31st March FY17 FY18 FY19E FY20E Year to March FY17 FY18 FY19E FY20E Share capital 4,790 5,133 5,224 5,224 Net int. income/assets 3.5 3.1 3.3 3.3 Reserves & Surplus 552,835 629,320 704,298 788,810 Fees/Assets 1.6 1.6 1.6 1.6 Net worth 557,625 634,453 709,522 794,033 Invst. profits/Assets 0.6 0.3 0.4 0.3 Sub bonds/pref cap - 5,000 10,000 15,000 Net revenues/assets 5.7 5.0 5.2 5.2 Deposits 4,143,788 4,536,227 5,493,588 6,691,520 Operating expense/assets (2.3) (2.4) (2.3) (2.2) Total Borrowings 1,050,309 1,475,162 1,580,656 1,687,531 Provisions/assets (2.3) (2.6) (1.3) (1.1) Other liabilities 262,955 262,455 317,570 384,260 Taxes/assets (0.3) - (0.5) (0.6) Total liabilities 6,014,677 6,913,296 8,111,336 9,572,344 Total costs/assets (5.0) (4.9) (4.1) (3.9) Loans 3,730,694 4,396,503 5,319,769 6,436,920 ROA 0.7 - 1.1 1.3 Cash and Equivalents 502,562 434,549 471,100 535,615 Equity/assets 10.4 10.0 9.7 9.2 Gilts 930,079 1,112,107 1,273,364 1,466,334 ROAE (%) 6.8 0.5 11.7 14.3 Others 357,855 426,654 446,639 467,624 Fixed assets 37,469 39,717 36,170 32,348 Valuation parameters Other Assets 456,019 503,766 564,294 633,504 Year to March FY17 FY18 FY19E FY20E Total assets 6,014,677 6,913,296 8,111,336 9,572,344 Adj. Diluted EPS (INR) 15.4 1.1 30.2 41.2 Credit growth 10.5 18.1 19.9 20.0 Y-o-Y growth (%) (55.5) (93.0) 2,710.6 36.4 Deposit growth 15.8 9.5 21.1 21.8 BV per share (INR) 232.8 247.2 271.6 304.0 EA growth 11.7 15.4 17.9 18.6 Adj. BV per share (INR) 207.6 201.9 232.5 269.5 SLR ratio 17.9 18.5 18.0 17.5 Diluted P/E (x) 35.4 505.8 18.0 13.2 C-D ratio 96.8 104.4 103.3 101.7 Price/ BV (x) 2.3 2.2 2.0 1.8 Low-cost deposits 51.4 53.8 53.4 54.2 Price/ Adj. BV (x) 2.6 2.7 2.3 2.0 Provision coverage 59.5 51.6 58.0 64.7 Dividend Yield (%) 0.9 - 1.5 1.5 Gross NPA ratio 5.3 7.1 6.0 5.2 Net NPA ratio 2.3 3.8 2.7 2.0 Incremental slippage 6.0 8.3 3.2 3.0 Net NPA / Equity 15.5 26.2 20.6 16.2 Capital adequacy 14.9 17.4 16.9 16.6 - Tier 1 11.9 14.3 13.9 13.5

Peer comparison valuation Market cap Diluted P/E (X) Price/ Adj. BV (X) ROAE (%) Name (USD mn) FY19E FY20E FY19E FY20E FY19EFY20E Axis Bank 20,633 18.0 13.2 2.3 2.0 11.7 14.3 DCB Bank 849 17.7 14.2 2.1 1.8 11.9 13.0 2,520 11.9 9.2 1.4 1.2 11.0 12.9 HDFC Bank 78,945 26.4 21.1 4.0 3.5 17.3 17.4 ICICI Bank 27,186 13.5 9.7 2.2 1.9 12.9 16.3 IndusInd Bank 16,792 26.2 20.6 4.4 3.7 17.4 18.8 681 6.1 4.8 0.8 0.7 11.3 13.1 36,861 34.9 28.6 4.9 4.2 14.8 15.7 - 14.5 11.0 2.8 2.3 19.6 21.8 Median - 17.7 13.2 2.3 2.0 12.9 15.7 AVERAGE - 18.8 14.7 2.8 2.4 14.2 15.9 Source: Edelweiss research

14 Edelweiss Securities Limited Axis Bank

Additional Data Directors Data Sanjiv Misra Director & Non Executive Chairman Shikha Sharma Managing Director & CEO V. Srinivasan Deputy Managing Director Rajiv Anand Executive Director Rajesh Dahiya Executive Director Prasad Menon Director Samir K. Barua Director Som Mittal Director Rohit Bhagat Director Usha Sangwan Director S. Vishvanathan Director Rakesh Makhija Director Ketaki Bhagwati Director B. Babu Rao Director V. R. Kaundinya Director

Auditors - S.R. Batliboi & Co. LLP *as per last annual report

Holding - Top 10 Perc. Holding Perc. Holding BNY Mellon 5.44 Dodge & Cox 3.67 Harris Associates LP 3.40 Capital Group Companies INC 3.09 Blackrock 2.69 Vanguard Group 2.38 ICICI Prudential Asset Mgmt Co 1.77 Franklin Templeton India Pte Ltd 1.61 General Insurance 1.51 FMR LLC 1.47 *as per last available data

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*in last one year

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded 23 May 2018 Shri R Sivakumar Sell 27500.00 11 May 2018 United India Insurance Company Limited Buy 75000.00 11 Apr 2018 United India Insurance Company Limited Buy 45000.00 06 Apr 2018 United India Insurance Company Limited Buy 15487.00 23 Mar 2018 Shri Sidharth Rath Sell 40000.00

*in last one year

15 Edelweiss Securities Limited RATING & INTERPRETATION

Company Absolute Relative Relative Company Absolute Relative Relative reco reco risk reco reco Risk HOLD SU M Axis Bank HOLD SU M Bajaj Finserv BUY SP L Bank of Baroda BUY SP M Bharat Financial Inclusion BUY SP M Capital First BUY SO M DCB Bank HOLD SP M Dewan Housing Finance BUY SO M Equitas Holdings Ltd. BUY SO M Federal Bank BUY SP L HDFC HOLD SPL HDFC BankBUY SOL ICICI Bank BUY SO L IDFC Bank BUY SP L Indiabulls Housing Finance BUY SO M IndusInd Bank BUY SP L Karnataka Bank BUY SP M Kotak Mahindra Bank BUY SO M L&T FINANCE HOLDINGS LTD BUY SO M LIC Housing Finance BUY SP M Magma Fincorp BUY SP M Mahindra & Mahindra Financial Services HOLD SP M Manappuram General Finance BUY SO H Max Financial Services BUY SO L of India HOLD SU M Muthoot Finance BUY SO M Oriental Bank Of Commerce HOLD SP L Power Finance Corp BUY SO M BUY SP M Reliance Capital BUY SP M Repco Home Finance BUY SO M Rural Electrification Corporation BUY SO M Shriram City Union Finance BUY SO M Shriram Transport Finance BUY SO M South BUY SO M State BUY SP L HOLD SP M Yes Bank BUY SO M

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Ratings Criteria Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

16 Edelweiss Securities Limited Axis Bank

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098. Board: (91-22) 4009 4400, Email: [email protected]

Aditya Narain

Head of Research [email protected]

Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services Allahabad Bank, Axis Bank, Bharat Financial Inclusion, Bajaj Finserv, Bank of Baroda, Capital First, DCB Bank, Dewan Housing Finance, Equitas Holdings Ltd., Federal Bank, HDFC, HDFC Bank, ICICI Bank, IDFC Bank, Indiabulls Housing Finance, IndusInd Bank, Karnataka Bank, Kotak Mahindra Bank, LIC Housing Finance, L&T FINANCE HOLDINGS LTD, Max Financial Services, Multi Commodity Exchange of India, Manappuram General Finance, Magma Fincorp, Mahindra & Mahindra Financial Services, Muthoot Finance, Oriental Bank Of Commerce, Punjab National Bank, Power Finance Corp, Reliance Capital, Rural Electrification Corporation, Repco Home Finance, , Shriram City Union Finance, Shriram Transport Finance, , Union Bank Of India, Yes Bank Recent Research

Date Company Title Price (INR) Recos

29-May-18 Rural Stress recognised upfront; 120 Buy Electrification growth looking up; Corporation Result Update

28-May-18 Max Financial Good performance; new 474 Buy Services strategic partnership on cards; Result Update 26-May-18 Bank of Stress upfronting mar 141 Buy Baroda performance; growth looking up; Result Update

Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to

Rating Distribution* 161 67 11 240 Buy appreciate more than 15% over a 12-month period * 1stocks under review Hold appreciate up to 15% over a 12-month period > 50bn Between 10bn and 50 bn < 10bn

Reduce depreciate more than 5% over a 12-month period Market Cap (INR) 156 62 11

One year price chart

650

600

550

(INR) 500

450

400 Jul-17 Jan-18 Jun-17 Oct-17 Apr-18 Feb-18 Sep-17 Dec-17 Aug-17 Nov-17 Mar-18 May-18 May-17 Axis Bank

17 Edelweiss Securities Limited Banking and Financial Services

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18 Edelweiss Securities Limited Axis Bank

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