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Karur Vysya Bank (KVB)- Highly Efficient Mid-Cap Bank + A Steady Compounder

Content Index

• Karur Vysya Bank – Investment Snapshot :- Slide #4

• Industry Opportunity – An Overview:- Slide #6

• Karur Vysya Bank – Business Overview :- Slide #11

• Investment Rationale :- Slide #17Investment Rationale :- Slide #17

• Karur Vysya Bank – Financials:- Slide #23

• Concerns & Reasoning :- Slide #25

• Conclusion :- Slide #29

“ Specialists in discovering Multibagger stocks “

Karur Vysya Bank (KVB) – Investment Snapshot (as on April 26, 2012)

Recommendation :- BUYAccumulation Range :- 370-400Returns Expected :- ~25% CAGR

Current Market Price – Rs. 400.75

Bloomberg / Reuters Code – KVB IN/ KARU.BO

BSE / NSE Code – 590003 / KARVYS

Mkt Cap (INR BN / USD Mn) – 42.91 / 818.9

KVB was started in the year 1916 in Karur by the duo of M.A.Venkatarama Chettiar & Athi Krishna Chettiar with a seed capital of just around 1 Lakh Rs.

KVB has since then consistently grown into a leadingfinancial institution, offering banking services to Millionsof customers and a Market Capitalization of 4300 Cr Rs. Itis one of the few Old Private sector banks which continuesto operate well in the changed scenario.

KVB has made profits consistently for the past 95 years ofits banking operations. It has also declared uninterrupted

Mkt Cap (INR BN / USD Mn) – 42.91 / 818.9[1 USD – Rs. 52.40]

Total Equity Shares [Mn]– 107

Face Value – Rs. 10

52 Week High / Low – Rs. 437 / Rs. 315

Promoter’s Holding – 3.26 %

Institutional Holding – 27.88 %

KVB has made profits consistently for the past 95 years ofits banking operations. It has also declared uninterrupteddividend since its inception.

KVB from being a Tamilnadu centric bank has startedexpanding its operation across the nation with theopening of several branches in North India. This helps indiversifying its base and also decrease the risk ofgeographical concentration.

Karur Vysya Bank has been a strong institution with wellentrenched business relationships with its customers. KVBis known for its Customer Service and Trust amongst itsclients, depositors and shareholders.


Key Investment Highlights

Modern Old Private Sector Bank – KVB is one of the most efficient bank in India. Most of the Old privatesector banks have not been able to grow out of their geographies or community base, but KVB is as good asany New-Age Private sector banks. It is one of the early adopters of technology in their operations and all itsbranches are CBS enabled. KVB has also been able to modernize itself on all fronts.

Healthy Growth Story – KVB has been growing at a healthy pace over the past several years on all fronts. ItsNet Profit has been able to Compound at over 20% from 2007-11 which displayed resilience of the bank’sprofitability in spite of the economic downturn. Its branch network has increased by more than 50% in thepast 5 years indicating the potential growth and Margin expansion in the coming years.

Efficiency Parameters – KVB is well capitalized with a strong CAR of over 13.25%. NIM’s are strong at 3.06%, RoAA is at 1.54%, Net NPA’s less than 0.3% and Coverage Ratio of over 80% which shows the operational quality of the bank. Bank has been able to maintain low NPA’s in spite of significant business growth over the quality of the bank. Bank has been able to maintain low NPA’s in spite of significant business growth over the past few quarters, indicating the superior Credit appraisal processes .

Share-Holder Friendly Bank – KVB has been a very shareholder friendly bank with a dividend of 120% forthe past 5 years. During FY 2010-11, the bank has rewarded its shareholders by Bonus shares at 2:5, and alsoissued rights shares at 2:5 (after bonus) with a low premium of Rs. 140. We expect similar offering from thebank during its Centenary year of 2016.

Hugely Attractive Valuations – KVB in spite of above average fundamentals is not getting the premiumvaluation it deserves. It is quoting at nearly half the P/B or P/E of banks like HDFC and IndusInd whichprovides scope for valuation expansion in the coming days. KVB’s attractive valuations has already startedattracting “Smart Money” from several reputed investors.


Industry Opportunity & Potential- An Overview- An Overview


Indian Growth Story• Though there are people who have started to doubt the Indian Growth story, we are very bullish on it. We feel this is a passing phase and India will get back to a high growth trajectory.

• We also believe that the “Best of Indian Growth” is ahead of us and the country will enter into a phase where it will achieve near double-digit growth for several years in a row.

• Banking is the best bet to profit from the country’s GDP growth. As a thumb rule, Banking sector growth is usually 2.5X the GDP growth.

• Indian banks are well run and have good return ratios when compared with banks across the developing economies.

• With a strong regulator in RBI, our banking system is mature enough to handle Macro-Economic risks.


Robust Banking GrowthHuge Moats for Banks :-

• India as a country is still very much under banked and there is a huge scope for improving the banking penetration and expanding the system.

• There has been no new banking licenses issued in the past decade and any growth in the country is being shared within the existing banks.

• Demand for Financial services • Demand for Financial services outstrips the supply which is helping the banks to grow profitably and this will continue in the next decade.

• Banking shares have been one of the top performers in the last decade with a high compounding growth.

• Efficient banks will continue to garner market share and will grow at a higher pace than the Industry and these stocks are low-hanging Multi-Baggers.


BANKEX has grown from 1,700 to 15,000 in less than 8 years

Cyclical Banking Uptrend


• Indian Banking has suffered a lot during the past 18 months because of high inflation and steep RBI hikes. Interest rate cycle has topped out and we can expect the banks to perform well going forward.

• High Interest rates affect credit demand, Increases NPA leading to lower NIM’s and Profits for the banks. With RBI reducing CRR and Repo rate aggressively, we can expect the banking margins to improve.

• Banks which are not saddled with high Restructured Assets will gain from this reversal and continue to grow handsomely in the coming quarters.

Bullishness on Private Banks Vs Public Sector Banks• Indian Private sector banks have outperformed Public sector banks on all fronts and gained a strong foothold.

• Public sector banks have to deal with Government Interference, Low Capitalization and Banking unions which have led to increased volatility in their business performance over the decade.

• We are very positive on the future of the Indian private banks and we believe that they will continue to gain market share because of their efficiency. share because of their efficiency.

• Though PSB stocks are available at cheaper valuation, we think that the markets are pricing the high risk associated with them.

• Moreover, even at higher valuations Private Bank stocks have outperformed PSB by a good margin.

• Within Private Sector Banks, efficient banks like KVB has performed even better on both business and stock markets.


Net Profit Margin

Karur Vysya Bank – Business Overview


Key Highlights

ROE – 20%ROA – 1.5%

NIM – 3.06%Cost/ Income – 40%

Gross NPA – 1.4% Net NPA – 0.29%

Strong Parameters

KVB has been on a branch expansion spree. Nearly 150 new branches has been opened in the

last 4 years, taking the total Branch network to 450. Bank

plans to grow its network by 10%

Branch Expansion KVB’s share price has multiplied by 20X in the past 10 years and over

150X in the past 20 years indicating the wealth creation in the stock.

KVB plans to achieve Total Business

Robust Track Record

Karur Vysya Bank plans to grow its network by 10%

YoY in various geographies.

Bank has been recognized for its operational excellence with Best

Bank awards from CNBC, Business-Today, KPMG, IDBRT, FE etc.

Excellence Awards

Bank has a strong discipline in maintaining its lending mix, risk mitigation and customer profile.

Management has a good vision for the bank with strong execution skills

and experience.

Healthy Culture + Trusted Brand

KVB plans to achieve Total Business of 1.25 Lakh Cr business by 2016

which implies a CAGR of >23%Bank


Distribution Network

• Karur Vysya Bank has a strong Distribution network with most of its branches located in Tamil Nadu + Andhra Pradesh where it has a strong brand image and rich legacy.

STATE Branches

TAMILNADU 228

ANDHRA PRADESH 97

KARNATAKA 34

MAHARASHTRA 25

GUJARAT 15

KERALA 11

DELHI 8

WEST BENGAL 8

PUNJAB 5

HARYANA 4

Category Dec 11

On-site ATMs 433

Off-site ATMs 272

Total 705

Metro18%

Urban29%

Semi-Urban39%

Rural14%

Branch Split-Up


brand image and rich legacy.

• Management is opening new branches across India to diversify and reduce its Geographic concentration. Bank has been able to do good business even from its non-traditional geographies.

• KVB is expanding its branches at 10% YoY and this along with normal business growth will help it to achieve its Target Business of 1,25,000 Cr business from the current 52,000 Cr by 2016.

• KVB has good % of its branches in Semi-Urban and Rural markets which has helped it to meet its Priority lending targets easily. KVB has also been able to build a strong Agri lending portfolio over the years.

HARYANA 4

ORISSA 4

M.P. 3

UTTARPRADESH 3

PONDICHERY 2

RAJASTHAN 2

CHANDIGARH 1

CHATTISGARH 1

GOA 1

JHARKHAND 1

Grand Total 452

Rich History + Fresh Energy

• Karur Vysya Bank in spite of being one of the oldest Private sector banks in the country, has been the frontrunner in adopting new technologies and changing itself to meet the need of its young customers.

• All the 452 Branches of the bank are CBS enabled. KVB is not burdened with the legacy problems like other OLD banks and has also diversified itself from its core community base.

• KVB now provides all kinds of new services to its customers which young private sector banks like ICICI, HDFC and Axis provide. KVB provides Internet Banking, Credit Cards, Mobile banking, NRI banking etc.

• KVB has a strong internal culture which helps it to grow aggressively without compromising on the quality of growth. Top management have been dynamic and highly professional.


KVB - Banking Parameters

• Karur Vysya Bank has been able to grow its

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Deposits Advances

KVB’s Owned Funds in Rs Cr

• Karur Vysya Bank has been able to grow its banking operations at a steady rate.

• In spite of good growth in Business, KVB’s Non-Performing assets have been flat.

• Karur Vysya generates strong internal accruals leading to lower equity dilution when compared with other private sector peers.

• KVB’s owned funds has grown at a compounded rate of around 18% in the past 5 years.


Important Parameters


• KVB’s fee income now contributes to more than 3/4th of its other income. Fee income of a bank is a steady cash business and its growth is a good sign.

• Company’s profits are less dependenton the Treasury sale profits which reduces the volatility in its earnings.

• RBI’s rate cuts of 75-100bps will increase PoSI in the next fiscal year.

Investment Rationale


Margin LeversKVB’s Business Mix KVB’s Deposit Profile


• Karur Vysya Bank’s CASA ratio has been slipping for a while. Partially due to the interest rate environment favoring FD’s and partially due to new branch additions. The new branches when mature, will provide scope for increasing the CASA ratio. Management has targeted achieving a CASA ratio of 30% in the medium term.

• Karur Vysya Bank’s Credit-Deposit ratio is less than 73% which provides scope for improvement and this will lead to better margins. Also with the cut in CRR, KVB will have sufficient scope to hold (or) improve its NIM’s. We expect the margins to bounce back to their average levels in the medium term.

• Operational efficiencies and Fee income will also get a decent boost with the tie-ups with 3rd party providers and branch addition. These along with Cyclical Banking improvements will lead to better Margins and Profits for Karur Vysya bank.

10 Year Snapshot


• KVB has shown consistent growth in operating income and profits for the past 10 years. There was a major drop in profits in 2004-05 because of a increasing interest rate environment which led to higher provisioning on its treasury portfolio and one-off shift in the value of its Bond holdings.

• Presently, treasury operations contribute less to its overall profits and moreover a drop in the current interest rates will lead to higher MTM profits from its bond holdings. KVB’s 10 year performance is as good as any other Top Bank in the country.

Awards & Recognition

KVB’s performance has been well recognized with several awards like,KVB’s performance has been well recognized with several awards like,

Best bank Award for Mobile Banking among small Banks - IDRBT Banking Technology Excellence Awards, 2010-11, by IDRBT, Hyderabad.

Best Cost Efficient Private sector Bank- FIBAC Best bank Award,2011 by FICCI & IBA.

Best Old Private Sector Bank – CNBC TV 18 Best Banks & Financial Institutions Awards 2011 by CNBC-TV18 & MCX.

Best Old Private Sector bank Runner up – FE India Best Bank Awards,2011.

EDGE AWARD from Information Week Magazine for Best IT implementation.

Business World – Price Waterhouse Coopers Best Bank Awards, 2011 – Best Small Bank and Fastest Growing Small Bank.

Business Today – KPMG - Best Mid-sized Bank - Quality of Assets. Second Place in the Mid-sized banks category.


KVB Vs other Banks


• Banking is a business of getting deposits and lending them profitably. On the lending front, KVB has a strong ingrained culture for better risk appraisal which shows in the NPA numbers. KVB has very little exposure to the stressed sectors like Airlines, Infrastructure, SEB’s etc. Hence, we can expect KVB to report decent NPA going forward.

• The bank has better recovery mechanisms and adequately provides for Provisions which makes sure that the Bank is well capitalized to handle any risks. KVB’s wrote-back several provisions which it had provided for during the downturn of 2008-09 and this boosted its profits tremendously in the next year.

• Karur Vysya Bank has the highest (Profit After Tax/ Average Assets) amongst all banks in the past 5 years. Consistent Fee income growth is one of the important reasons for this achievement.

Comparative ValuationsPeer Banks Operational Parameters Valuation Parameters

Private Sector ROA (E) NPM RONW ROE (FY-11) PE Ratio Dividend Yield

HDFC Bank Ltd. 1.60% 16.09% 15.47% 16.75% 24.6 3%

Dhanlaxmi Bank Ltd. 0.50% 2.49% 3.02% 4.06% 20.96 1%

Development Credit Bank Ltd. 1.30% 3.31% 3.62% 14.20% 19.88 1%

ICICI Bank Ltd. 1.34% 15.91% 9.27% 9.66% 18.97 2%

ING Vysya Bank Ltd. 0.91% 9.56% 12.05% 13.45% 17.62 1%

YES Bank Ltd. 1.50% 15.56% 19.17% 21.13% 17.5 1%

Axis Bank Ltd. 1.47% 17.20% 17.87% 19.34% 13.59 1%

Karur Vysya Bank Ltd. 1.54% 16.82% 20.71% 22.26% 10.32 3%


• KVB in spite of strong operational parameters which is inline with Large banks, has been quoting at a significant valuation discount to them. In all important parameters like ROA, NPM and RONW - Karur Vysya Bank is amongst the top 3 private sector banks which indicates its efficient operations.

Karur Vysya Bank Ltd. 1.54% 16.82% 20.71% 22.26% 10.32 3%

South Indian Bank Ltd. 1.00% 11.10% 17.31% 18.52% 9.24 2%

Karnataka Bank Ltd. 0.89% 7.80% 8.39% 9.63% 8.54 3%

Lakshmi Vilas Bank Ltd. 0.80% 8.49% 12.44% 13.04% 7.88 2%

Jammu & Kashmir Bank Ltd. 1.30% 15.23% 17.68% 18.96% 7.19 3%

Financials


Earnings Projection Income Statement (INR Cr) FY 10 FY 11 FY 12E FY 13E

Net Interest Income 564 766 902 1118

Other Income 247 264 318 384

Total Income 812 1031 1220 1502

Salaries 163 229 263 327

Overheads 349 430 525 645

Total Provisions 37 39 107 158

Tax 90 146 103 158

• KVB’s top-line will grow at a healthy pace due to strong growth in its lending book and Other income growth.

• There has been a compression in margins due to cyclical factors in banking. We expect margins to rebound from FY-14.

We don’t expect any significant Tax 90 146 103 158

PAT 336 415.6 482 536

Diluted EPS 62.2 44.9 45.2 50.1

ROAA % 1.7 % 1.7 % 1.5 % 1.3 %

ROAE % 22.6 % 22.3 % 20.2 % 18.7 %

Adjusted Book Value 174 223 251 286

• We don’t expect any significant equity dilution in the coming 2 years and hence ROE will increase owing to better leverage of funds.

• Provisioning demand will start to moderate which will provide a strong boost to the bottom-line of Karur Vysya Bank.

Specialists in discovering Multibagger stocks “

Concerns & Reasoning1.) Decreasing Return Ratios :

Banking being a cyclical industry goes through bad phases (past 2 years) when there is a huge increase in the interest rates which affects NPA’s, Provisioning, Treasury Operations, NIM’s etc. Evidently these get reflected in the lower ROA’s and ROE’s. With the Interest rate cycle reversal, we expect the bank to maintain or slightly improve its Return ratios going forward.

2.) Muted Bottom-line Growth in the past 2 years :

Banks bottom-line has not grown significantly because of the compressions in margins. This is due to steep interest rate increase, new branch addition etc. Growth in expenses will moderate and this along with stabilizing NIM’s will help the banks bottom-line to grow at a similar pace to that of its top-line.


3.) Low CASA Ratio :

KVB’s lower CASA ratio is a matter of concern and the management intends to shore this up in the coming quarters which will help in better margins. Moreover, high interest rates led retail customers to move to competing savings products and attractive FD’s. KVB’s branch addition will help it in building a strong CASA franchise in the coming years.

4.) Lower Retail Assets:

KVB’s loan portfolio has very little Auto loans, Personal loans etc. But, company works with NBFC’s to sell customized lending solutions to its customers. Thus, the bank hopes to boost its Fee income which is a strong source for profits. Company has tied up with M&M Finance to provide tractor loans to its clients.

Conclusion


Price Chart

KVB Price Range

Share Holding %

Dec 2011

Sept 2011

June 2011

Mar 2011

Promoters 3.26 3.27 3.46 3.51

FII 21.2 20.92 22.63 21.43

DII 6.68 6.79 4.83 4.23

• KVB is the best performing banking stock in the past 12 months. It has out-performed BANKEX by a significant margin. This shows the stability of the stock.

• KVB has been trapped in a price range with very little price volatility. With good results expected over the next 2 quarters, we expect the stock to break out of its trading range and deliver good returns for its shareholders.


KVB’s Attractiveness• KVB has been trading at the middle end of its historic valuations in spite of better business performance.

• KVB with improved fundamentals, increased scale of operations and higher Return ratios will tend to trade at >2X Book value in the future.

• Stocks attractiveness has attracted a lot of good investors (or) Smart money with the likes of Chryscapital picking

P/E Band

with the likes of Chryscapital picking up a significant chunk in the bank.

• Indian Market’s Legendary investor Rakesh Jhunjhunwala continues to hold KVB stock for more than 15 yearswhich shows his conviction in the growth of the bank.

• Once shares change hands from weak investors to smart investors, the stock will be ready for a good bounce.


Recent Bulk Deals in KVB :-

1.) Chryscapital – 3.91% on Mar-9, 2012.2.) Wharol – 1 Million shares on Mar-20, 2012.3.) Goldman Sachs – 0.8% on Mar- 21, 2012. 3.) Olympus Capital – 4.8% on Apr-18,2012.

Big Bull Rakesh Jhunjhunwala holds over 4.3% stake in KVB.

ConclusionWe believe that Indian Banks are the best proxies to profit from the Country’s growth. When the country

is expected to grow at near double digit rates over the next several years, country’s banks should grow at arate of 2.5 times the GDP growth and Karur Vysya Bank being a well run bank should definitely out performthe industry by a few basis points and that is a very serious growth of over 20% consistently. With its lowbase, KVB will continue to increase its market share profitably.

Karur Vysya Bank’s margin levers along with its increasing scale is not being reflected in its stock price. It’shugely undervalued when compared to other well-run private sector peers like Yes Bank, IndusInd Bank,Axis, HDFC etc. This is for a Bank which has one of the lowest NPA’s, High ROE’s, Low Cost/Income Ratio andHighest Net Profit/ Total Assets which indicates the quality of its operations.

A well managed Private sector Bank with the best Industry Parameters is available at 1.4X its ProjectedA well managed Private sector Bank with the best Industry Parameters is available at 1.4X its ProjectedBook and less than 8X its Fy-13 Earnings. Its not rocket science to understand that, we are buying into thestock at attractive valuations. Risk in the investment is very low considering its consistent Performance underdifficult circumstances over the past several decades. Moreover, KVB’s uninterrupted dividend along with itspresent Dividend Yield of over 3% makes it highly attractive.

Karur Vysya Bank is a perfect SIP stock. We are buying into a strong compounding stock at the lowerend of its historic valuations. Hence, the Bank’s inherent +20% profit growth along with scope forvaluation expansion will lead to strong returns for its long term shareholders. In short - KVB stock will beable to give >2X returns, compared to what the Bank gives for its FD Holders. Accumulate the stock andjust look at the Wealth creation that happens in the next few years.


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