Can Bank reported strong NII growth in 3QFY11. In FY12, we expect pressure on NIMs, which should largely be offset by moderate growth in operating expenses. We build in higher credit costs in FY12, though we believe these can surprise positively. The price correction offers an opportunity, in our view. Buy.

3QFY11: Strong NII growth
Net interest income (NII) grew 43% yoy (6% qoq) on the back of 29% yoy (8% qoq) loan growth and 50bp margin expansion to 3.21% in 3QFY11 (+5bp qoq). Core fee income came down 8% yoy (1% yoy in 9MFY11) and treasury gains were about 2% of PBT in 3QFY11 (22.6% in 3QFY10, see Chart 2). The bank estimated its pension liability at Rs22bn-23bn to be provisioned off over five years (Rs1bn in 3Q; Rs3.4bn in 9MFY11). Management estimated the gratuity liability at about Rs4.2bn to be fully provisioned off in FY11 (Rs2bn in 3QFY11; Rs3.2bn in 9MFY11).

Asset quality largely stable; consistently higher cash recovery provides comfort
Gross NPLs remained largely stable qoq in 3QFY11. According to management, cash recovery in 9MFY11 was Rs12bn, or about 46% of opening GNPLs of around Rs26bn in April 2010 (Note that cash recovery as a proportion of opening gross NPLs was 73% in FY10 and about 100% in FY09). The proportion of total stressed loans, at 6.2% (1.6% GNPLs + 4.6% restructured loans) was largely in line with peers.

Margins to come under some pressure
According to management, wholesale deposits (certificates of deposit) constitute 13-14% of total deposits. Wholesale borrowing costs have risen sharply in the recent past and this will likely translate to a higher cost of funds for the bank in the medium term. However, infrastructure loans constituted about 23% of the loan book as of December 2010, which is high compared to about 15% for the banking sector. This, we believe partly contributes to higher yields at Can Bank. On balance, we factor in an 11bps yoy decline in NIMs in FY12F.

Changes in estimates; price correction makes valuations attractive; upgrade to Buy We increase FY11F net profit by 10% and keep FY12F profit largely unchanged. Further, we include a 30% discount to our fair value (from 20% earlier) for likely equity dilution and restructured loans and, so, arrive at a target price of Rs681 (from Rs746). The recent stock price correction offers an opportunity, in our view, and, hence, we upgrade to Buy.