(Editor’s Note: There is much greater liquidity on the NSE India under the ticker YES).
YES BANK (OTC:YYBKY) is the fifth largest private bank in India and is arguably one of the best managed banks in the world as well as one of the most innovative banks in the world. The bank made its debut on the Forbes 2000 list earlier this year and currently has a market share of about 1% of the Indian banking industry. It is expecting steady customer growth of approximately 25% per annum to garner a 2.5% market share within five years.
Banking the Unbanked
If a person takes the 25% number at face value, it may seem a bit high but given the significant number of people in India who do not currently have a bank account, this number may, in the greater scheme of things, seem quite conservative.
The World Bank's Global Findex report indicated that, at the time of reporting, the unbanked population in India represented 21% of the world's total unbanked population of more than 2 billion people. This represents approximately 420 million unbanked people in India, it should also be noted that this figure does not even take into account the millions of dormant accounts at state-owned banks in India. It can certainly be said that the number of unbanked persons in India has probably declined since 2014 but it is common knowledge that a significant portion of the population remains unbanked.
(Source: World Bank Findex database)
Banks have found it challenging to introduce these unbanked persons to its services and has had even greater struggles in monetizing these clients. YES BANK has, however, proven itself highly capable of banking the unbanked and monetizing these clients. One of the programs it has used to bring financial services to the unbanked is its YES SIM Sleeve solution (introduced in partnership with Taisys) which enables the user to perform payment transactions, remittances and P2P transfers via encrypted SMSs from any cellular phone.
The fact that the payment can be effected by an ordinary cell phone (feature phone), as opposed to only a smartphone, is essential to its success given that there are approximately 700 million feature phones in India compared to 200 million smart phones. The vast majority of the unbanked population are also inhabitants of rural and/or remote areas where the prevalence of feature phones is higher.
This program in conjunction with YES BANK's continuous digital banking expansion puts the bank in the perfect position to continue growing and to become the bank of choice for an ever-increasing portion of persons who are currently unbanked.
Digitalization enhances the bank's growth prospects
YES BANK has invested significantly into digital platforms. Its YES Money program is one of the largest domestic remittance programs in India and has more than 5.1 million customers and a total throughput of INR 13,000 Crores (approximately $19.5 million). YES BANK has also become the largest issuer of virtual prepaid cards in the World on MasterCard's platform, having issued 1.7 million virtual prepaid cards at the time of reporting its full year 2016 results and has issued a further 700,000 virtual prepaid cards in the first quarter of 2017 to bring the total to 2.4 million.
YES BANK is also very active on social media and has been ranked amongst the Top 5 Global Bank Brands on Social Media by The Financial Brand publication. The bank's YES TAG banking application also allows its customers to perform banking transactions on Facebook Messenger, WeChat, Telegram and Skype. The chart below compares YES BANK's social media following to that of its peers, who are significantly bigger than it.
Click to enlarge(Source: YES BANK Q1FY17 Press Release)
These digital strategies will enhance the bank's competitiveness, particularly amongst the younger and more tech-savvy segment of the population, and aids in reducing the cost of banking. Reduced costs will further encourage the unbanked to consider YES BANK over its competitors, particularly in light of the fact that more than 23% of the unbanked surveyed for the World Bank Findex indicated cost as one of the primary reasons for not having an account. These digital strategies also reduce the need for access to bank branches, which is another highly cited reason for remaining unbanked.
The risk outlook for the company and investors
Investors and economists have expressed significant concerns over rising non-performing loans (NPLs) at Indian banks. The total level of gross NPLs in the Indian banking system has risen to above 5% and the Reserve Bank of India, its central bank, has expressed concerns that many banks have not adequately provisioned for NPLs. These banks have been required to increase these provisions after the Reserve Bank's audit.
Rising NPLs may have a negative impact on YES BANK. I am, however, of the view that this area is one of YES BANK's competitive advantages and showcases its good management. The bank reported gross NPLs (it reports it as non-performing advances) of about 0.79% at the time of its annual report for the full year 2016. NPLs have remained constant for the first quarter of 2017. This clearly indicates that total NPLs at YES BANK is significantly below that of the Indian banking sector at large and also below that of other private sector banks in India that have average gross NPLs of 2.1%.
The bank has seen rising non-performing assets; I am, however, of the view that this is a natural consequence of its growth and remain impressed with management's ability to keep the level of NPAs significantly below that of the broader Indian banking sector. The bank also reported a decline in the level of restructured advances as a proportion of gross advances from 0.71% to 0.49% in the first quarter of 2017. This is a positive development in the bank's risk outlook.
(Source: YES BANK 2016 Annual Report)
The bank's significant diversification of its loan portfolio across a large number of sectors is demonstrated in the chart below. This extensive diversification has significantly contributed, and is likely to continue contributing, to the bank having a lower level of NPLs than most other Indian banks. In the sectors where the bank has an above-average exposure, it has appointed specialized risk and relationship managers. The bank's continuous focus on effective risk management further enhances my positive view of its long-term prospects.
(Source: YES BANK Q1FY2017 Press Release)
The bank has quite a substantial exposure to the electricity sector; its loans to this sector are, however, largely to power generation facilities that are already in operation. The bank has also proven to be one of the leading financiers of renewable electricity sources, which currently represents about 2.8% of its loan book and the vast majority of the projects financed have commenced with operations. It is less exposed to the struggling steel sector, which represents approximately 1.9% of its total loan book.
US investors in YES BANK also have to consider the currency risk involved as the bank ultimately earns and reports its earnings in Indian Rupees (INR). The INR can be volatile and may depreciate against the USD should the Fed raise interest rates later this year. US-based investors should also take cognizance thereof that YES BANK trades as an unsponsored ADR in the US and there is generally a lack of pricing information available for these ADRs on most major financial websites.
There is also the potential that current investors may be diluted through capital raises; the bank currently has approval to raise up to $1 billion in capital, subject thereto that the capital raise may not dilute existing shareholders by more than 15%.
Capital ratios are some of the most important metrics any investor investing in a bank needs to consider. In its first quarter of 2017, the bank reported a common equity Tier 1 capital ratio (under Basel III) of 10.3% which is well above the required minimum.
The bank has also maintained a monthly average liquidity coverage ratio (LCR) of 83.1%, which is well above the required regulatory minimum LCR ratio of 70%. The bank's strong capital position reduces the need for future dilutive capital raises.
Growth potential in asset management and retail investment services
A significant portion of the Indian population doesn't currently enjoy the services of any asset management company. The fast-rising middle class is increasingly requiring asset management and other investment services.
YES BANK has recently received an in-principle approval from the Securities & Exchange Board of India (SEBI) to sponsor a mutual fund and to set up an asset management company. I foresee that the expansion into the asset management industry will benefit and enhance the company's long-term growth prospects. The new asset management business is in addition to its YES SECURITIES (India) Ltd. subsidiary that reported its second full financial year at the time YES BANK reported its full year 2016 results.
YES SECURITIES, which is not yet profitable, reported a 452% increase in revenue for the full year over the same time period in the previous financial year. This subsidiary currently represents less than 1% of the bank's total revenues. It is, however, likely to grow substantially over the next few years, particularly in light of the fact that the subsidiary has slightly more than 54,000 customers, which represents only a fraction of the potential number of clients.
YES SECURITIES' introduction of a mobile stock trading platform, although hardly as innovative as its other digital banking services, has also proven very popular and was a large contributor to its growth. The bank's continuous focus on the digital space will further encourage retail investors to make use of its services.
Earnings in Review
In the first quarter of 2017, the bank reported a 38.1% increase in net income over the same quarter in the previous financial year, which was strongly supported by a 65.2% increase in non-interest income and to a lesser extent by a 24.2% increase in net interest income.
(Source: YES BANK Q1FY17 Investor Update)
The bank saw a 63% YoY increase in current and savings accounts (CASA), which saw the CASA ratio improve from 23.4% a year ago to 29.6% at the time of reporting. This is a significant indicator that the bank's continued focus on expanding its retail business is proving to be successful. Retail deposits now make up more than 55% of the bank's total deposits.
The bank also reported an increase of approximately 30% in total loans, with total loans now amounting to about 0.87 times total deposits.
The stock has rallied by more than 75% YTD, on the local market, which may concern some investors and encourage some to wait for a pullback before buying this stock.
(Source: 4-traders on TradingView)
The stock is currently trading at a TTM p/e ratio of 21.44 which is above its five-year average p/e ratio of about 15.4. The stock is currently trading at about 3.7 times book value, which may seem excessive at face value, but given the company's CAGR of more than 22% in its book value makes it seem less overvalued.
YES BANK is expected to grow its EPS at a CAGR of 30% over the next five years, which, although seemingly high, is actually relatively conservative given that the bank's growth has been accelerating as it's gaining critical mass in various markets. I am nevertheless factoring in a margin of safety of 20% in determining the value of YES BANK.
The expected growth in EPS after factoring in the 20% margin of safety is thus 24% per annum; wherefore the bank's EPS is likely to stand at about 177.72 INR compared to its current EPS of 60.62 INR. The amount was calculated as follow: 60.62 (1+0.24) ^5 = 177.72. This EPS value is then multiplied by the bank's five-year average p/e ratio of 15.4 to give a value of INR 2,736.89, which should in turn be discounted by the investor's desired growth rate.
I consider a 15% rate of return as reasonable, and therefore consider a fair value for the bank at about 1,214.37 INR, which is about 6% below its current price.
The bank represents a significant long-term growth opportunity, but is somewhat overvalued at its present price. The ideal buying opportunity will thus come after a slight pullback in the share price. I do not, however, foresee any substantial decline in the share price and should the bank continue growing at its present pace, its average p/e ratio will adjust upwards.
Take note thereof that figures are indicated in INR largely as a result of weak pricing data in the US. The ADR price should, however, be a reflection of the price of the underlying stock adjusted for currency differences and the number of shares represented by the ADR.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.