Buy YES Bank Ltd.

Target Price:Rs244.00
CM Price:Rs186.00

Recommendation
The bank has registered a compounded growth rate of around 60 per
cent since it interception. We expect the bank to continue to grow at a high rate.

We are very positive on the long term business prospects of the company and financial performance. At Current Market Price of INR 165.05 the stock is trading at a PE of 16.15x. With expected EPS for FY10 and FY11 of INR 17.73 and INR 19.32 respectively, the stock is trading at a PE of 9.7x and 8.9x respectively.

The price of the stock is undervalued at current level of INR 165.05. We reiterate “BUY” on the stock with target price of INR 244.00 with a medium term investment horizon. The Upside for the stock is INR 79.00.

Highlights/Recent Updates

Growth plan of the bank
Yes Bank operates 123 branches across India and expect to target grow to 250 branches by the end of the current fiscal year to 750 branches by March 2015 and with 3,000 ATMs. The bank also expects staffing to grow from about 2,000 to 10,000 in 2015.

Bank focus strongly on growth of its core banking business

Yes Bank has reconsidered some of its diversification plans such as launching an asset reconstruction company. The company will instead focus strongly on growth of its core banking business. The planned initiatives to start an asset reconstruction company, asset management and a broking subsidiary are not in the bank immediate horizon.

Banking Industry – Funding the Economy

Banking Industry is an essential part of any economy. In fact, banks are the single most important supplier of credit. The banking industry has the capital and commitment to support the financial needs of individuals, businesses and all levels of government. Banks make loans to consumers to finance purchases of homes, education, cars and major appliances. Bank credit helps small businesses get started, grow and prosper. Banks help state and local governments fund a variety of public improvements like schools, roads, water & sewer and public health facilities. In each of these roles, banks support the creation of jobs and the growth of our economy.

Banking Industry is the most dominant sector of the financial system in India, and with good valuations and increasing profits, the sector has been among the top performers in the markets. But currently worldwide the banking industry is facing a tough time due to the failure of financial system in the biggest economy i.e. United State of America. The problem arises due to default in sub prime mortgage lending clubbed with rising national debt, current account deficit, and fiscal policies of US. This has led to the failure of some big investment banking firm leading to file bankruptcy. Financial Institutions are the one to face the toughest challenge.

Indian Industries has witness an indirect, knock-on effect of the global financial situation and is a reflection of the uncertainty and anxiety in the global financial markets. While no country in world remained completely insulated from the global financial crisis, Indian banking industry was better placed to cope with the adverse consequences of the financial turmoil. India is relatively better placed due to its robust policy framework, stricter prudential regulations with respect to capital and liquidity and strong growth performance. Recently we have experienced few positive signs that indicate the recovery of the economy. Increase in primary demand clubbed with stable government has built a strong confidence in the mind of investor.

An added obstacle to the sustained improvement of the banking system is the fact that banks are mandated to provide funding to government- defined priority sectors dominated by small-scale business and agriculture. Loans to these sectors are at high risk of be-coming nonperforming. Private-sector banks must ensure that 25 per cent of their loans are directed towards these priority sectors; for state-owned banks, the figure is 40 per cent. These thresholds restrict the level of credit available to more efficient companies in non-priority sectors.

The level of bad loans has been falling in recent years as a result of the creation of asset-reconstruction companies and a rapid expansion in lending. Non-performing assets (NPA) fell to less than 1.0 per cent for the fiscal year 2008-09. In the near future, for a stint, we expect to see an increase in Non-performing Assets.

COMPANY OVERVIEW

Yes Bank began its operation in August 2004. In June 2005, when the company issued Initial Public Offering (IPO), it received a wonderful response and the IPO was oversubscribed by 25 times.

Yes Bank mainly operates in four segments: Treasury, Corporate wholesale Banking, Retail Banking and Other Banking Operations. It provides various banking and financial solutions in India. It offers financial and risk management solutions to large corporations and groups, multinational companies, central and state governments, government bodies, and public sector enterprises. It also provides advisory and financial solutions across various sectors, including food and agribusiness, life sciences, technology, and infrastructure comprising renewable energy, education, healthcare, and water management; and business banking solutions comprising financial market services, trade and treasury services, and account services, as well as term loans and working capital.

The company’s corporate finance services include advisory and credit linked products for the infrastructure sector clients; structured and project finance solutions for non-infrastructure clients; and specialized advisory services on financial restructuring.

It also offers retail banking services, such as wealth management and global Indian banking services; and retail products comprising savings and current accounts, fixed deposits, and retail loans. Further, the company offers private equity syndication services; advisory services related to mergers and acquisitions, divestitures, joint ventures, spinoffs, IPOs, open offers, rights issues, private placements, share buy backs, capital restructuring, distressed debt, and equity buy outs; and brokerage services. Additionally, it provides foreign exchange services, online Forex solutions, fixed income, derivatives and structured products, commodity risk management advisory, and liquidity and balance sheet management; and transaction banking services that include cash management services, capital market and escrow account services, trade services, and trade finance services.

The bank operates through 123 branches and over 200 ATMs in India. In a general sense, the facilities offered by the Yes Bank are: Corporate and Institutional Banking

Financial Markets

Investment Banking

Business and Transactional Banking

Retail Banking

Private Banking

Transactions Banking

The bank has a motto of technological advancement with well equipped modern day amenities like net banking, phone banking and mobile banking.

CARMELS Strategy – Must for Banking Industry

The statutory mandated areas for banking industry are solvency, liquidity and operational health. For analyzing banking industry, the
model we prefer is known as CARMELS. The ‘CARMELS’ model stand for: Capital Adequacy, Asset Quality, Resource raising ability, Management & System evaluation, Earning potential, Liquidity/Assets Liability Management and System & Control.

(a) Capital Adequacy: Capital represents the level of cushion or protection available to the company creditor’s to absorb losses from credit and other risks. It is measured by the ratio of capital to risk-weighted assets (CRAR). A sound capital base strengthens confidence of depositors. The CRAR for the year end stands at 16.63 per cent where as 17.63 per cent for the June quarter. The CRAR of Yes bank is higher as compare to the statutory requirement by the RBI.

(b) Asset Quality: Asset quality is a primary consideration when assessing credit risk of a finance company. One of the indicators for asset quality is the ratio of non-performing loans to total loans (NPA).
The Net NPA for Yes Bank stands at 0.33 per cent for the last year end and 0.24 for the June quarter. The NPA of Yes bank is very stable as compare to its peers and industry average.

(c) Resource raising ability: Since funds are finance company’s raw material, its ability to generate them is essential for its operating model. The bank plans to rise between $150 million to $250 million through equity sale early in next year, and could also look to raise tier II capital worth about $100 million in the current calendar year. The share of the bank is trading at more than 3 times to it book value.

(d) Management & System evaluation: The quality of a company’s management, its business strategies and its ability to track and respond according to changes in market condition. The ratio of noninterest expenditures to total assets is one of the measures to assess the working of the management. The non interest expenditure to total assets for the bank stands at around 2.81 per cent which is very low as compare to its peers. This variable includes a variety of expenses, such as payroll, workers compensation and training investment.

(e) Earnings potential: Earnings are the key input for supporting growth. Earning potential directly attract debt and equity. Earning is directly related to the growth of revenues of the bank. Yes bank has registered a continuous and robust growth in its earning since its interception.

(f) Liquidity/Assets Liability Management: Cash maintained by the banks and balances park with central bank is an indicator of bank’s liquidity. Bank has access to call market or RBI refinance facilities in the event of liquidity crunch. The banks properly manage the time difference between short term deposits with long term loans. Yes bank has registered a growth of around 33.20 per cent in the cash and balance with RBI. It’s a strong indication of the liquidity of the bank.

(g) Systems and Control: The Systems and control access plays an important part in today’s highly advance banking technology. Due to electronic technology advancement, the bank needs to have access as well as control over the systems. Safety and security plays a vital role in today world.

SWOT ANALYSIS

Strength
Easier Funding
After the slowdown and liquidity crisis in FY09, the wholesale funded financials, IDFC and Yes Bank, are this year expected to reap benefits of easier funding environment, as their funding costs drop faster than peers’ and aid market share gains.

Margin improvement due to expansion of CASA deposits
We have witness an improvement in the CASA over the past few quarter. There is an upside movement of around 200 bps over the past 8 quarters. We expect further improvement in the CASA deposits, which will helps the bank to register an increase in the margins.

Parental Support
Robo bank is among one of the biggest promoter of Yes bank. Yes bank always has a parental support and state-of-the-art benefits from Robo Bank. Robo bank is a Nederland based bank which is world’s single AAA rated private Bank.

Weakness
Loan book
The loan book of Yes bank largely comprised corporates and SMEs. We have witnessed that the share of SME has gone up. This can put an upward pressure on NPAs for the bank. We expect the asset quality to stay healthy despite challenging macro conditions. The stress was witnessed in only a single account, which was fully provided for in the initial quarters, according to the management.

Rising NPA could have an impact on earnings
Rising NPA, which is still low as compare to its peers and industry, could have an impact on the earning capabilities of the company.

Opportunity
Large market
India has a population of more than a billion. This helps the player to cover a bigger and rural market. Still there are lots of untapped market.

Rising disposable income
Increase in disposable income has resulted in demand of different financial products and hence a new way to bet on the top line of the company.

Threats
Non Banking Financial Institution (NBFC)
NBFC are offering other financial services and eating up the share of the banks.

Reserve Bank of India persuade banks to lower the spread RBI can persuade banks to lower the spread which have a direct and hard impact on the margins for the service provider.

PEST Analysis
PEST analysis of any industry investigates the important factors that affect the industry and influence the companies operating in the sector. PEST stands for Political, Economic, Social and Technological analysis. The PEST Analysis is a tool to analyze the forces that drive the industry and how those factors can influence the industry.

Political Factors
Focus on Regulations
Indian Banking is least affected as compare to other developed economy which is attributed to Reserve Bank of India for its robust policy framework, stricter prudential regulations with respect to capital and liquidity. This gives India an advantage in terms of credibility over other countries.

High Capital Adequacy Ratio
The Implementation of Basel II norm has stricter rules and regulations. India’s regulatory systems are places above China and Russia; and at par with Japan and Singapore.

Economic Factors
Growing Economy
Indian economy has registered a growth of more that 9 per cent for last three year prior to the current year ended. The regulatory body took several steps to fight against the slowdown. We expected Indian economy to maintain higher growth rate as compare to other developed and developing countries.

Low Interest Rates
Reserve Bank of India controls the Interest rate, which is based on several monetary policies. Recently RBI has reduced the interest rate to stimulate the growth rate of banking industry.

Social Factors
Loyalty Factor
Banking industry services is lending and borrowing of funds. The banks need to have a good royalty factor as compare to counter part in other countries. The financial meltdown on Indian Banks is less impact as compare to other countries.

Increased Penetration of Cards
India has registered a robust growth in plastic money. There is a still lot of potential in the plastic market. India spends around 1 per cent of their total purchases through credit cards where as the world average is stands more that 9 per cent.

Technological Factors
IT Services & Mobile Banking
Technology advancement has changed the face of traditional banking systems. Technology advancement has offer 24X7 banking even giving faster and secured service.

OUTLOOK
Robo Bank is the largest share holder of the company. Robo bank, Nederland based, can acquire more shares to enter in Indian market. This will leads into gain for minority shareholder.

The bank has registered a compounded growth rate of around 60 per cent since it interception. We expect the bank to continue to grow at a high rate.

We are very positive on the long term business prospects of the company and financial performance. At Current Market Price of INR 165.05 the stock is trading at a PE of 16.15x. With expected EPS for FY10 and FY11 of INR 17.73 and INR 19.32 respectively, the stock is trading at a PE of 9.7x and 8.9x respectively.

The price of the stock is undervalued at current level of INR 165.05. We reiterate “BUY” on the stock with target price of INR 244.00 with a medium term investment horizon. The Upside for the stock is INR 79.00.

Report card

Attribute	Value	Date
PE ratio	17.38	14/09/09
EPS (Rs)	10.23	Mar, 09
Sales (Rs crore)	542.65	Jun, 09
Face Value (Rs)	10
Net profit margin (%)	12.35	Mar, 09
Return on average equity	18.7	Mar, 09

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