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| Positives priced in | |
| Sarath Chelluri / New Delhi July 6, 2009, 0:00 IST | |
Even as SBI consolidates, concerns pertaining to profit margins and asset quality haven’t vanished
While concerns over asset quality and margin pressure weighed in on the stock of State Bank of India (SBI) till end-March 2009 given the economic slowdown, the stock has done pretty well in the recent past. Post election results (a stable government leading to better growth), expectations over reforms (FDI in insurance and consolidation in banking sector) and a whopping 60 per cent jump in advance tax payout by SBI are among key triggers for the outperformance. Although some pressures have eased in the recent past, the overall economic outlook is still far from the stage where it could be termed as encouraging. In this background, analysts expect a muted growth in the bank’s profit for 2009-10, and are largely neutral on the stock.
Consolidating
On June 19, the country’s largest bank, SBI, proposed the merger of its 98 per cent subsidiary, State Bank of Indore (SBIN), the smallest of its associates, with itself. The announcement comes about a year after the first merger proposal pertaining to State Bank of Saurashtra (SBS).
| VALUATIONS |
| in Rs crore |
FY08 |
FY09 |
FY10E |
| Net interest income |
17,021 |
20,873 |
25,812 |
| Other income |
8,695 |
12,691 |
11,459 |
| Total income |
25,716 |
33,564 |
37,270 |
| Net profit |
6,729 |
9,121 |
9,542 |
| P/E (x) |
17.0 |
12.6 |
12.0 |
| P/BV (x) |
2.3 |
2.0 |
1.8 |
| E: analyst estimates |
SBIN’s total business is about 4.4-4.6 per cent of the parent’s and would add about 3.5 per cent to SBI’s net profit. What is important is the signal it sends. Experts expect that the long-term prospect of merging all the subsidiaries is positive. Put together, SBI’s associates have a branch network of 4,600 (comparable to the second largest public sector bank, PNB) or around 29 per cent of SBI’s standalone reach (profit-wise, they would 23 per cent to SBI’s standalone numbers).
Once Government extends approval, O P Bhatt, SBI Chairman believes that process of merger will not take more than three to six months. And, it will help SBI effectively compete in an increasing competitive environment. While integration would be smoother as all of concerned banks have a common platform, the positive part is that a merger would avoid duplication in places where SBI and its associates are currently competing with each other and, lead to cost savings. While the bank will have to convince employees of SBIN, given the leaning from the SBS merger, the management sounds confident.
Asset quality concerns
Coming to the bank’s core business, SBI grew its advances at 28 per cent on an average in the last five years. The slowdown in the economy and a rapid growth of advances earlier is likely to catch up on the asset quality. While the banks net non-performing assets (net NPAs) look manageable at this stage at 1.76 per cent in 2008-09, RBI’s move providing banks the flexibility to restructure loans (assets) has also helped. On a closer look, restructured loans and pending loan restructuring applications at SBI stood at 2.4 per cent and 2 per cent of total loans (2008-09), respectively, are a concern. Put together, the three work out to 6.16 per cent of total loans in 2008-09.
The other issue is the company’s provision cover at 39 per cent, which is the lowest among PSU banks and suggests that the bank is not conservative to provide for bad loans. Analysts say that the bank’s lower provisioning is helping in boosting its profitability. To give a hypothetical example, if provision coverage was pegged to 50 per cet, the net NPAs would have reduced from the actual 1.8 per cent to around 1.4 per cent but net profit would have been 40-50 per cent lower (compared to Rs 2,750 crore reported) in the March quarter.
Nevertheless, larger restructuring and pending applications suggest that there could be deterioration in the future (if economic outlook does not improve) with pressure coming from sectors like real estate and small-and-medium enterprises. Thus, analysts expect NPAs to rise in 2009-10.
Margins under stress
SBIs net interest margins (NIMs) stood at 3.2 per cent for most of the previous fiscal year (see chart Under Pressure). However, a rise in cost of deposits during 2008 (peak levels in December) have pulled down margins subsequently to 2.5 per cent in the March 2009 quarter (average of 2.9 per cent for 2008-09). Apart from a dip in share of low-cost CASA deposits, the 8 per cent home loan scheme (launched in February 2009) and mobilisation of funds through special deposit schemes like 1,000 day run (launched in October 2008) in this period at higher rates were among reasons for the lower margins.
Since October 2008, the bank cut its lending rates by 200 basis points (including cut of 50 bps to be effective from June 29) to 11.75 per cent, whereas in the same period, the deposit rates were cut in between 175 to 250 bps. As interest rates on newer deposits were cut aggressively, the overall cost of funds would decline, which along with the decline in bulk deposit rates will sustain margins. Going ahead, expect the blended margins to decline marginally to 2.7-2.8 per cent.
Outlook
The likely improvement in living standards of individuals residing in rural and semi-rural areas along with sustained focus of the government will help banks that have presence in these regions. SBI has an extensive network in these regions (about 70 per cent of total branches) and is best placed to leverage this to its advantage (eg. mobilise low-cost deposits). The bank has been strongly focussing on improving operational efficiencies, which is reflecting the steady decline in its cost-to-income ratio at 46.6 per cent. In the interim though, recruitment of about 34,000 employees in 2008-09 and another 13,000 planned in 2009-10 could put some pressure on the cost side.
Favourable bond yields helped SBI report a 171 per cent growth in treasury profits at Rs 2,567 crore in 2008-09 (Rs 1,509 crore for March 2009 quarter), which boosted profit growth. However, it may be difficult to replicate similar treasury gains in 2009-10 with an inch-up in bond yields. A slower loan growth, lower treasury gains and likely increase in NPAs suggest that net profits would grow at 10 per cent in 2009-10.
Besides the core banking activities, analysts have pegged a value of around Rs 400-450 per share of SBI on account of the value of affiliate banks, insurance businesses and other investment. Any move to unlock value should rub-off positively on the SBI stock. However, adjusting for the embedded value, at Rs 1,811, the stock is trading at 1.35 times its estimated 2009-10 book-value, which is reasonably fair and factors in most of the recent positive developments. Investors may consider getting into the stock on dips.
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