DCB Bank: Maintain ‘add’ on stock with increased TP of Rs 89 from earlier Rs 87

DCB Bank’s (DCB) Q2FY21 earnings were driven by strong NII growth and tight cost-control. NII grew by a strong 9% quarter on quarter (QoQ), driven by sharp 32bps QoQ NIM expansion. It continues to build contingency buffer with further provision of Rs480 million towards Covid, which takes the cumulative buffer to Rs 4billion (~1.60% of standard loans).

Notably, it remains committed to building granular retail liability with focus on increasing retail TD share (top-20 deposit share fell to 7.9% in Sep’20 from 9.3% in Mar’20) and reducing bulk-deposit share. Collection efficiency (88% / 91% in LAP & home loans respectively), single-digit non-paying customer pool and recovery in SMA accounts are encouraging.

However, RoA improvement from the current level of 0.86% is likely to be prolonged, given elevated credit costs and muted loan growth expected over next three-four quarters. Current valuation at 0.7x FY22E ABVPS largely captures the near-term concerns on growth and asset quality, in our view. Maintain ‘add’ with an increased target price of Rs 89 (earlier: Rs 87), valuing at 0.75x FY22e ABV.

Credit growth remains muted; expect to start picking up from Q4FY21. Deceleration in loan growth, which started in Q4FY19, continued and fell 1% QoQ in Q2FY21. Amid a highly uncertain environment, the management highlighted that its near-term focus would be on capital conservation. Hence, the emphasis would be on growing gold, home, tractor and business loans selectively. Gold loans are likely to grow fastest and reach 10-11% of total loans from currently 4% over the next couple of years. Given its conservative stance in growing the balance sheet, DCB estimates the credit portfolio in FY21E to remain flat YoY or decline marginally. However, given its niche in financing small-ticket self- employed customers and its Tier-1 capital comfortable at >14%, we expect DCB’s credit growth to revive quicker than peers.

Cost rationalisation to continue. Management highlighted that the cost ratio at current level is not sustainable and is likely to increase with pick-up in business volumes. But over the medium term, it plans to reduce cost/asset ratio to 2.2% from 2.4% in FY20. For the full year FY21, it expects total cost to decline by 8-10% YoY and NII to remain flat YoY.

Asset quality held up well in Q2FY21 with coverage ratio increasing to 64%; non-paying accounts now stand in single digit. Fresh slippages in Q2FY21 remained negligible at Rs90million due to the Supreme Court’s interim order, but the management prudently increased the coverage ratio to 64% on the existing NPL pool to factor-in delayed recovery due to Covid. Overall, GNPA ratio improved to 2.27% (proforma at 2.39%) while the NNPA ratio fell to 0.83%. DCB further strengthened its balance sheet by building additional Covid-related provisions, taking the total buffer to Rs 4billion, or ~160bps of loans. Collections in LAP and home loans improved to 88% and 91%, respectively. Management estimates potential incremental restructuring of 3-5% in the coming quarters.