Professional Documents
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INTRODUCTION
Banking in India originated in the last decades of the 18th century. The oldest bank in existence
in India is the State Bank of India, a government-owned bank that traces its origins back to June
1806 and that is the largest commercial bank in the country.
Currently, India has 88 scheduled commercial banks (SCBs) - 27 public sector banks, 31 private
banks and 38 foreign banks.
According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75
percent of total assets of the banking industry, with the private and foreign banks holding 18.2%
and 6.5% respectively.
With the growth in the Indian economy expected to be strong for quite some time-especially in
its services sector-the demand for banking services, especially retail banking, mortgages and
investment services are expected to be strong.
Axis bank
Axis Bank was established in 1993 and was the first private sector bank to start operations after
the Government of India allowed entry of private banks. Previously called UTI Bank, Axis Bank
was promoted by Unit Trust of India (UTI-I), Life Insurance corporation of India (LIC), General
Insurance Corporation (GIC) and its four subsidiaries, New India Assurance Company, Oriental
Insurance Corporation, National Insurance Company and United Insurance Company. The name
of the Bank was changed in 2007 as there was brand confusion because many unrelated
shareholder entities such as UTI Securities, UTI Technological Service and UTI Investor
Services were also sharing the UTI brand. Moreover, the name was changed to connote stability
and solidarity as well as was in line with the bank’s expanding operations across geographical
boundaries. Staring with one branch in Ahmedabad in 1994, the bank now has 835 branches
including extension networks (31st March 2009) across 30 States and 4 Union Territories. The
bank also has overseas offices in Singapore, China, Hongkong and Dubai.
The bank's broad products and services include consumer banking, NRI business, retail loans,
corporate banking, treasury, capital markets and financial advisory services. It divides its
business into five segments viz. large corporates, SMEs, agri-business, channel financing and
structured products. The bank's retail assets constituted 23 per cent of total advances at the end
of March 2008. Housing loans accounted for 57 per cent of total retail assets. Auto loans
constituted 7 per cent of its retail loans
The bank divides its advances into three focus areas i.e. agricultural, mid--corporate and SMEs.
During 2007--08, the bank's agricultural advances grew by 35 per cent to Rs.5,507 crore. Its
advances to SMEs reported a whopping 74 per cent growth to Rs.11,536 crore.
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The bank maintains a healthy asset quality with 81 per cent of its corporate advances having a
rating of at least `A' as at the end of March 2008. The bank pruned its net stressed assets
consistently from 1.92 per cent in 2002--03 to 0.36 per cent by end of 2007--08.
Consistent growth: The bank’s net profit has grown by over 30% YoY in 36 out of the last 38
quarters. Also the two quarters in which the profit did not grow was on account of write-off of
extraordinary items (G-Sec valued on mark to market basis). The net profit has grown by over
60% YoY in each of the last eight quarters. The important performance indicators such as ROA,
CAR, NPA and NIM have remained strong over the last five years. Axis Bank comes very near
to HDFC Bank in terms of important efficiency parameters. As can be from the table above, the
share of current account saving account deposits in the total deposits (CASA) is higher in case of
HDFC Bank. Also HDFC Bank scores higher in terms of margins (NIM). However, looking at
the returns generated on networth (ROE) and the growth in advances and deposits, Axis Bank
appears to be gearing up well to reduce the gap existing in the margins as well as the total
balance sheet size.
Expanding footprint, expanding balance sheet: The bank has continued to expand its
geographical coverage across the country. Over the last five years, the total number of branches
including extension centers of the bank has increased from 339 in FY05 to 835 in FY09 whereas
ATMs have increased from 1,599 to 3,595. Also during Q1FY10, the bank added 26 new
branches including extension centers and 128 ATMs. This has helped the bank particularly in the
acquisition of low cost retail deposits, retail assets, lending to agriculture, SME and mid-
corporates as also the sale of third-party products. The bank’s balance sheet has increased at a
CAGR of 43.65% over the last five years
Key Positives
Post its rebranding exercise in 2007 the bank has continued to do well and the change in name
has not affected the bank’s business. In fact in FY2008 it saw its customer acquisition grow at a
robust rate of 67% over the last year to over 9.9 million customer accounts
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OBJECTIVES
1. To ascertain the price per share of Axis Bank, through the technique of DCF valuation.
3. To determine the Equity multiples of Axis Bank using Relative valuation approach.
4. To interpret and comment upon the deviation of calculated values from the actual values,
if any.
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METHDOLOGY
A. DCF Valuation
The valuation of AXIS Bank is done using the DCF valuation approach. In this approach two
separate models were used for calculation of value of equity and Value of firm, using FCFE and
FCFF concepts respectively.
Bombay Stock Exchange Limited constructed a new index, christened BSE-500, consisting of 500 scrips
w.e.f. August 9, 1999. The changing pattern of the economy and that of the market were kept in mind
while constructing this index.
BSE-500 index represents nearly 93% of the total market capitalization on BSE. BSE-500 covers all 20
major industries of the economy. In line with other BSE indices, effective August 16, 2005 calculation
methodology was shifted to the free-float methodology.
Number of 500
scrips
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4. Historical Beta :
Beta is a relative measure of market risk. Beta of the company reflects the change in
returns of the company share viz-a-viz that of the market.
Historical beta was calculated using regression on the respective returns of the share of
Axis bank and that of BSE 500.
The time period was of 5 years, from April 04 to March 09. The 30 days average daily
returns were taken for this purpose.
Cost of equity was calculated using the CAPM (capital asset pricing model)
Ke = Rf + (Rm – Rf) * B
Where,
Ke = cost of equity
RM = market proxy return (average) .The market proxy chosen in this case was BSE
500.
β = Levered beta of Axis Bank.
Rf = The expected risk-free return in that market (government bond yield)
(RM-Rf) = The risk premium of market assets over risk free assets.
6. Cost of debt (Kd):
It reflects the minimum interest rate to be paid for holding that debt.
The after tax cost of debt was calculated using the formula:
The tax rate used was equal to 33% which is the current rate of corporate tax.
The cost of capital is an expected return that the provider of capital plans to earn on their
investment.
The cost of capital was calculated using the WACC method.
Ko = We*Ke + Wd*Kd
Where,
We = equity ratio E / (D+E)
Wd = debt ratio D / (D+E)
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8. Reinvestment rate (RR):
It is the rate at which cash flows from fixed-income securities may be reinvested.
ROE= PAT / BV of equity (this value was taken directly from Prowess)
ROCE= EBIT (1-t) / capital employed (this value was taken directly from Prowess)
• Note: Since, there was a considerable difference between the fundamental growth of
axis bank and the Y-O-Y growth in PAT, the average of both was taken to arrive at
the total growth to be used for calculation purpose.
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11. Free cash flow to equity FCFE :
This is a measure of how much cash can be paid to the equity shareholders of
the company after all expenses, reinvestment and debt repayment.
FCFE = PAT - (net capex + change in working capital) * (1-(D/ (D+E))
Free cash flow to firm FCFF:
This is a measurement of a company's profitability after all expenses and reinvestments.
It's one of the many benchmarks used to compare and analyze financial health.
A positive value would indicate that the firm has cash left after expenses.
The time period for extra ordinary growth was taken to be 5 years because of the following plans
of the company:
i. Expansion plans: Axis Bank has aggressive plans to expand its branch network and
advance its extension counters to branches in South India.
(Source:
http://www.rupeetimes.com/news/personal_loan/axis_bank_to_spread_out_its_wings_in_south_i
ndia_1951.html )
ii. Axis Bank gets RBI approval for asset management company
Axis Bank Ltd has received the Reserve Bank of India’s (RBI) approval to set up an
asset management company (AMC) that will allow it to offer products such as mutual
funds.The bank is also exploring the options of entering the broking business.
(Source: http://www.livemint.com/2008/06/28004557/Axis-Bank-gets-RBI-approval-fo.html )
iii. As part of its strategy of building the organic growth engine, the Bank continued to
enlarge its geographical coverage of centers with potential for growth, including
district headquarters and other Tier II cities and towns across the country. This has
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helped the Bank particularly in the acquisition of low cost retail deposits, retail assets,
lending to agriculture, SME and mid-corporates as also the sale of third-party
products. During the year, 176 new branches were added to the Bank's network
(including 12 extension counters that have been upgraded to branches), taking the
total number of branches and ECs to 835 as on 31.3.2009 (against 671 branches and
ECs in the previous year). Of the 827 branches, 230 branches are in semi-urban and
rural areas. With the opening of these offices, the geographical reach of the Bank now
extends to 30 States and 4 Union Territories covering 515 centers. During 2008- 09,
the Bank opened 831 ATMs, thereby taking the ATM network of the Bank from
2,764 to 3,595.
(Source: annual report – 2009 axis bank )
In this phase the growth rate gradually declines to reach the stable stage growth rate.
Since the firm was in high growth a transition period of 6 years was taken.
For the stable stage Ke was calculated using debt-equity ratio of 1.45, which is the current
D/E ratio of SBI which is considered to be a mature bank, having stable growth rate.
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B. Relative Valuation
Relative valuation is a generic term that refers to the notion of comparing the price of an asset
to the market value of similar assets.
The most common methodology for individual equities is based on comparing certain financial
ratios or multiples, such as the price to book value, price to earnings, etc., of the equity in
question to those of its peers.
Relative valuation gives the comparable market value of the stock.
Steps in relative valuation:
1. Finding comparable assets prices by market (listed)
2. Market price of comparable assets is standardized using a common variable (P/E, P/B,
P/S…)
3. Adjusting for differences in the characteristics of comparable companies and companies
under valuation.
The coefficients were calculated by running regression on the comparable firms in the financial
services sector.
After filtering, 84 comparable firms were obtained.
Note: the P/E and P/B multiples values of comparable firms were taken directly from
prowess.
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P/S: Price to sales ratio
Price-to-sales ratio is a valuation metric for stocks. It is calculated by dividing the
company's market cap by the company's revenue in the most recent fiscal year (or the most
recent four fiscal quarters); or, equivalently, divide the per-share stock price by the per-share
revenue.
Note: the P/S values of comparable firms were calculated using formula
The equity multiples of AXIS Bank were calculated using the following equations:
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DATA ANALYSIS
1. Beta calculation
The beta was calculated = 1.019, for the extraordinary growth period.
Coefficie Standa
nts rd Error t Stat P-value
0.09266 0.0585 1.5833 0.1187
Intercept 2 24 18 87
X Variable 1.01958 0.1275 7.9949 6.25E-
1 3 29 36 11
Regression Statistics
0.72406
Multiple R 8
0.52427
R Square 4
Adjusted R 0.51607
Square 2
Standard 0.44945
Error 3
Observations 60
Note:
• Due to unavailability of sufficient information, the new beta for stable stage was
calculated assuming that the firm will reach the beta of a mature bank, State Bank of
India.
• SBI is a mature bank which has been maintaining a D/E ratio of 1.45 (source: Prowess)
over the years.
• We have assumed that Axis bank will also maintain a similar D/E ratio in the stable
stage.
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2. market returns
365 Days Index
year Returns
2002 2.15
2003 -8
2004 107.38
2005 21.89
2006 65.17
2007 9.81
2008 17.04
2009 -42.77
Rm 21.58375
Rf =4.5
Rm-Rf = 17.08
Note :
• The tax rate for the stable stage was assumed to increase to 40 %.
• The market returns Rm and risk free rate Rf were taken at the current rate.
4. DCF Valuation
Note:
• The equity reinvested rate is expected to gradually decline in the transition phase to reach
60 % in the stable stage.
• The extraordinary growth rate will also decline gradually in the transition phase to reach
16 % in the stable stage.
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Value during extraordinary growth period = Rs. 536.11
Value during transition period = Rs. 4562.233
Terminal value = Rs. 239128.5054
PV terminal value = Rs. 27031.70455
Price per share = Rs. 894.87 (as calculated from DCF valuation)
Current Price of AXIS Bank share = Rs. 917.60 (As on August 28, 2009)
Source: BSE
Note:
• The capital reinvestment rate is assumed to decline gradually in the transition phase to
reach 35 % in the stable stage.
• The growth rate is also expected to decline gradually from the extraordinary rate to 16 %
in the stable stage.
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6. Relative Valuation
Axis Bank
Payout Ratio = 0.232
Expected Beta = 0.994
Expected Growth Rate = 0.16
ROE = 0.1348
NPM = 0.132745
Result:
P/E = a+b1 (payout ratio) +b2 (g) +b3 (beta)
= 16.4
Note:
In the calculation of P/B ratio, the regression was conducted only on the values of payout ratio,
beta and ROE.
The growth was discarded from the regression because of the phenomenon of
Multicollinearity.
Multicollinearity is a statistical phenomenon in which two or more predictor variables in a
multiple regression model are highly correlated. In this situation the coefficient estimates may
change erratically in response to small changes in the model or the data. Multicollinearity does
not reduce the predictive power or reliability of the model as a whole; it only affects calculations
regarding individual predictors.
P/S = a+b1 (payout ratio) +b2 (g) +b3 (beta) +b4 (NPM)
= 2.8
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RESULTS
DCF valuation
The results of the DCF valuation show that the share of the Bank is fairly priced.
There is some variation of the actual price from the price calculated from the model.
The firm value of Axis Bank comes out to be Rs. 95,077.24 Crore.
Relative valuation
P/E 16.4 18.18
P/B 1.3 2.94
P/S 2.8 0.6495
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CONCLUSION
Knowing what an asset is worth and what determines that value is a prerequisite for intelligent
decision making – in choosing investment for a portfolio, in deciding on the appropriate price to
pay or receive in a takeover, and in making investment, financing and dividend choices when
running a business.
From this exercise of corporate valuation of Axis Bank it was found out that the current price of
share of Axis Bank is more than what was calculated from the DCF model.
The calculated P/E ratio of Axis Bank is lesser than the current market P/E ratio.
Both these results show that the share of Axis Bank is over valued.
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BIBLIOGRAPHY
1. Damodaran on valuation
By: Aswath Damodaran
2. www.bseindia.com
3. www.finance.yahoo.com
4. www.wikipedia.org
5. www.business-standard.com
6. Prowess database.
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