After stressed period of FY14–20 and slower growth post-COVID, this small-cap lender is poised for re-rating

Stock market today: The shareholders of Karnataka Bank, a leading 'A' Class Scheduled Commercial Bank, which was incorporated on February 18, 1924, at Mangaluru, Karnataka, have little to complain about as of now, as the stock has given over 78 per cent returns in the past one year. In comparison, the benchmark Nifty50 has risen over 29 per cent during the window. The lender, which witnessed a challenging period between FY14–20 before a stable period of FY05–13, is finally seeing green shoots of several steps the new management has taken in the past two years. 

The reorganisation of several departments, a robust underwriting process, and cross-selling opportunities are some of the factors that are working in favour of the lender.

"Post-COVID, the bank has been witnessing slower growth because of structural changes. Around one-third of the key management team has changed in the last two years, which includes the CEO, CFO, CPO, and CIO. The bank is poised for growth rejuvenation, aided by a comfortable LDR (74% as of Q3 FY24) and ample liquidity (LCR of 266%)," notes LKP Securities in its report dated March 26, 2024.

LDR stands for loan-to-deposit ratio, while LCR stands for liquidity coverage ratio.

The small-cap bank's stock on Tuesday, March 26, ended 0.67 per cent lower at Rs 230.15. Its market capitalisation stood at Rs 8,074.08 crore on the BSE. 

In the near term, major growth is expected to come from AA and AAA-rated corporate loans. However, retail loan pick-up would take time as organisational changes are in progress and the implementation process (which cannot be quantified) will be sooner than expected, the brokerage notes. 

"Moreover, we expect the bank’s margin (3.3% as of 3QFY24) to stay stable given the granular deposit franchise (78% LCR retail deposits) and the meaningful contribution of MCLR (22% contribution) and fixed-rate (22% contribution) linked loans. Along with asset quality improvement, we expect the credit cost to remain benign. The capital infusion (Rs 15 billion) would further strengthen the CET-1, which may dilute the ROE by 20 basis points; however, it would provide growth in the medium term," analysts at LKP Securities note.

The brokerage adds that it has conservatively estimated FY26E ROA/ROE of 1.2%/14.8% against the management guidance of 1.4%/16%. The improving growth, efficiency, and profitability may drive a re-rating for the bank as it trades below its book value (trailing P/B of 0.9x). "We are recommending a "BUY" given the favourable risk-reward," it adds. The target price has been set at Rs 304.

Karnataka Bank Q3 Results 

The private sector lender reported a 10 per cent rise in net profit to Rs 331 crore for the third quarter ended December 2023. The bank had earned a net profit of Rs 301 crore in the October–December quarter of 2022. The total income increased to Rs 2,439 crore in the third quarter of the current fiscal year compared to Rs 2,055 crore in the year-ago period.

The bank's interest income rose to Rs 2,113 crore from Rs 1,851 crore logged in the same period last fiscal. However, the net interest income (NII) declined to Rs 828 crore from Rs 835 crore registered at the end of the third quarter of last year.

The gross non-performing asset (NPA) ratio declined to 3.64 per cent as of December 31, 2023. In the year-ago period, it stood at 3.28 per cent.

However, the net NPA declined to 1.55 per cent compared to 1.66 per cent at the end of December 2022. The provision coverage ratio stood at 80.75 per cent at the end of December 2023, according to a PTI report. 

Source: LKP Securities