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The Financial Wizard

Its wide gamut of offerings will make Kotak Mahindra Bank a key beneficiary of the great Indian growth story

The history of Kotak Mahindra Bank (KMB) dates back to 1985 when Uday Kotak and Sidnery Pinto formed Kotak Capital Management Finance. A year later, in 1986, they were joined by Harish and Anand Mahindra of Mahindra & Mahindra and thus Kotak Mahindra Finance came into being.

Kotak Mahindra Finance started off as a finance company and in 2002, was converted into a bank - Kotak Mahindra Bank. And in a span of six short years, the bank has established itself as one of India's leading financial institutions with a range of services encompassing corporate finance, capital market financing, asset reconstruction, commercial vehicle finance, consumer finance, car finance, investment banking, mutual funds and life insurance. KMB offers finance solutions that encompass every phase of an individual's, and corporation's, life.

KMB has also had international partnerships with Goldman Sachs (one of the world's largest investment banks and brokerage firms), Ford Credit (one of the world's largest dedicated automobile financers) and Old Mutual (a large insurance, banking and asset management conglomerate) through joint ventures and subsidiary companies. The company's public issue came out in 1993. It also rewarded shareholders with bonus shares in 1995 (ratio 1:1) and in 2005 (ratio 3:2)

Investment Rationale
Demand for Financial Services
The coming years will see the Indian economy grow at a robust pace. Changing demographics, rising disposable incomes and changing mindsets would be the key drivers for GDP growth. India will be a preferred investment destination as compared to other emerging economies and the financial services sector will be at the forefront of this growth. The sector, which is a barometer of the state of the economy, has shown robust growth in the past few years as well. This growth is reflected in almost all areas - banking, asset management, brokerage and insurance. The financial sector is set to be a major beneficiary of the investment and consumption boom in India.

High Savings Rate
India's savings rate has been rising consistently over the past few years, having crossed the 30 per cent of GDP. The same trend has been witnessed in corporate savings as well. At present, most of the savings generated by households and the public sector are locked in bank deposits which yield a minimal rate of return. This reflects the low-risk appetite of most savers. But with the capital market witnessing a boom, several financial products (mainly equity-linked) have been launched with the intention of luring investors by offering superior returns. The recent market correction has not deterred financial institutions from coming out with new products either. This speaks volumes of the positivity and buoyancy in the financial services sector.

Changing Demography
The huge young population of the country makes for a strong domestic consumption story. India's age dependency is declining (from 80 per cent in 1970 to around 55 per cent now), which will in turn have a positive impact on household savings. There has been a rise in disposable incomes and spending power of the huge Indian middle class (one of the youngest population in the world), which will bring the wave of demand in the financial services sector.

Poised to Cash in on Opportunities
The bank is setting up a vast distribution network by leveraging on the brand name 'Kotak' and a strong net worth. The bank has established itself as a strong player in the securities and investment banking business as well, and is finding its feet in the banking insurance and asset management businesses.

Associated Risks
Dependency on Capital Markets
KMB's business verticals like the securities business, asset management and investment banking business are directly dependant on the performance of the capital markets in India. Hence any downturn will impact Kotak Mahindra Bank.

Fragmented Financial Services
Most segments in the financial services sector are highly fragmented, the entry barriers to the industry are low and hence, there is immense pressure on pricing power and profitability. Of late, consolidation has started taking place in the sector but any unwarranted consolidation in the sector may lead to pricing wars in the industry too. The asset management and brokerage segments have a high degree of market fragmentation, as a result of which pricing power tends to be in the hands of intermediaries and end-consumers, rather than the market players.

Exposure to Exotic Derivatives
KMB has designed a number of exotic derivative products for its corporate clients. This has been done to help the corporates hedge their forex exposure. However, any adverse movements in the spreads might result in market-to-market losses and credit losses for the bank if the corporate client refuses to honour the obligations.

Valuations
KMB's positive point is its diversified business mix. The bank is in a sweet spot to cash in on the ongoing boom in the financial services sector. Furthermore, the pedigree of the management at the helm will guide KMB to be a leader in the securities and investment banking businesses and also scale up the asset management and insurance business. Kotak Mahindra Bank is valued at 3x FY10E BV and the bank is expected to continue commanding such valuations with ROE's expected to rise to 20 per cent in FY10E from 11.3 per cent in FY07.