KRChoksey Research has updated its recommendation for Kotak Mahindra Bank to ACCUMULATE with a revised target price of Rs 2,025 from the current market price of Rs 1,871, offering a potential upside of 8.2%. The bank’s performance in Q2FY25 was steady, with growth in net interest income (NII) and stable advances. However, challenges such as rising credit costs in the unsecured retail segment and a slight dip in net interest margins (NIM) due to loan portfolio shifts were notable. The bank remains well-positioned with a focus on expanding its granular deposits and strategic acquisitions.

Performance Highlights for Q2FY25

Net Interest Income Growth
In Q2FY25, Kotak Mahindra Bank’s NII increased to Rs 70,196 million, a year-on-year growth of 11.5%. This growth was driven by a stable advance base, though it slightly underperformed the research house's expectations by 1.3%. The Pre-Provision Operating Profit (PPOP) was Rs 50,993 million, reflecting a 10.6% YoY growth. However, there was a 2.9% decline QoQ, primarily due to higher credit costs. The adjusted PAT came in at Rs 33,437 million, marking a moderate 4.8% YoY growth but a notable 5% decline QoQ, in line with expectations.

Impact of Loan Mix Shift on Margins
Kotak Mahindra Bank’s NIM stood at 4.91%, a decline of 31 basis points YoY, largely driven by a shift towards secured loans with lower yields. Temporary capital market activity, such as IPO deposits, also reduced returns on surplus deposits. Despite these pressures, the bank anticipates margin improvements in subsequent quarters, thanks to strategic adjustments in the loan book and the acquisition of the Standard Chartered unsecured portfolio.

Segment-Wise Growth

Advances and Deposits Expansion
The bank’s net advances grew by 14.7% YoY and 2.5% QoQ in Q2FY25, amounting to Rs 3,995 billion. The consumer segment drove much of this growth, with home loans increasing by 17.8% YoY and the business banking segment showing a robust 20.9% YoY growth. On the deposit front, Kotak Mahindra saw a 15.1% YoY increase, largely fueled by term deposits, which grew by 25.5% YoY. The CASA ratio (Current and Savings Account) remained a focus, although it showed a slight decline YoY, improving modestly by 19 bps QoQ to 43.6%.

Challenges in Credit Card and Retail Segments
The bank’s credit card segment reported 14.7% YoY growth but saw a slight 1.4% QoQ decline, primarily due to the RBI’s tech embargo affecting new card issuance. Personal loans saw healthier growth at 16.8% YoY. With unsecured loans comprising 11.3% of the total loan book, Kotak Mahindra expects recovery in the segment once regulatory hurdles are cleared.

Asset Quality and Credit Costs

Slight Deterioration in Asset Quality
As of September 30, 2024, the Gross Non-Performing Assets (GNPA) ratio stood at 1.49%, a slight increase compared to the 1.39% in June 2024. Similarly, the Net NPA (NNPA) ratio rose to 0.43%, driven by rising delinquencies in the credit card and microfinance segments. Slippages for the quarter increased to Rs 18,750 million, with credit costs escalating to 65 bps, up from 55 bps in the previous quarter. The management projects that these challenges will persist for two to three more quarters, particularly in the unsecured retail book.

Strategic Acquisitions and Future Outlook

Standard Chartered Acquisition and Tech Enhancements
Kotak Mahindra’s acquisition of Standard Chartered’s personal loan portfolio, which added 95,000 customers, is a significant move aimed at expanding the bank's affluent client base. The bank continues to focus on both organic and inorganic growth strategies to become India’s third-largest private bank over the next five years. With the RBI tech embargo lifted soon, Kotak is poised to ramp up digital onboarding and credit card issuance, which will contribute positively to its growth trajectory.

Outlook and Valuation

Valuation and Target Price
Despite facing challenges related to asset quality and tech restrictions, Kotak Mahindra Bank's diversified business model and emphasis on premium customer segments make it a resilient player in the banking sector. The research house expects the bank’s advances to grow at a 15.9% CAGR between FY24-FY26, with profits increasing at 7.4% CAGR. The bank is trading at a P/ABV multiple of 3.0x/2.6x for FY25E/FY26E. KRChoksey has revised its target price to Rs 2,025 per share, which represents an 8.2% upside from the current market price of Rs 1,871.

What Should Investors Do?

Short-Term Outlook
Investors with a short-term horizon should remain cautious as the bank navigates through challenges in its unsecured retail book and asset quality pressures. With rising credit costs and the ongoing effects of the RBI’s tech embargo, volatility may persist in the near term.

Medium to Long-Term Recommendation: Accumulate
For investors with a medium- to long-term view, Kotak Mahindra Bank remains a strong candidate for accumulation. Its strategic acquisitions, emphasis on premium clientele, and robust digital infrastructure are likely to drive sustained growth once the regulatory environment stabilizes.

Growth Catalysts
The bank’s focus on granular deposit expansion and strategic acquisitions, including its recent foray into the personal loan segment, combined with investments in technology, are poised to deliver long-term value. Kotak’s ability to balance growth while maintaining asset quality will be critical in the coming quarters.