Favourable valuation brings cheer to investors of Bank of Baroda

While Dena and Vijaya banks are taking a huge hit on valuations, the deal is seen accretive for BoB

From being perceived as a bitter pill to swallow to ending up in a favourable position, things have turned for the better for Bank of Baroda’s (BoB’s) shareholders.

While the early gains faded in the BoB stock due to a dull day of trade, Vijaya Bank and Dena Bank ended in the deep red on Wednesday, down 7.5 per cent and 20 per cent, respectively. More critically, with the swap ratio or share exchange ratio working in favour of BoB, the Street believes that a large part of uncertainty is now behind the stock.

As Vijaya Bank is stronger than BoB on parameters such as asset quality and capital adequacy, and Dena Bank is extremely weak on these parameters, the Street believed a merger would be grossly dilutive for BoB if it was treated at par with the other banks. 

However, analysts at ICICI Securities say the swap ratios restrict the equity dilution to 22 per cent as against 25 per cent estimated earlier for the merged entity. “The merger has proved prima facie beneficial for Bank of Baroda,” an analyst added.

The likely merger synergies also explain the Street’s optimism on BoB.

For one, the merger will make the combined BoB entity the third-largest bank in terms of advances, pushing ICICI Bank a notch lower. Rising to this position organically may take longer.

Based on the September quarter’s (Q2) earnings, the merged entity’s loan book would be about Rs 6.3 trillion and it would also be a more diverse book (see chart). 

 

Analysts at Motilal Oswal Financial Services have noted the retail book of the merged entity will increase to 20 per cent of loans due to the higher retail book of Vijaya Bank. For BoB, that’s a 400-basis-point increase.

Similar gains are also seen in the liability profile. While the overall share of low cost current account–savings accounts (CASA) deposits may dip from over 40 per cent for BoB now to 37 per cent post-merger due to Vijaya Bank’s 22 per cent CASA level, its deposit base increases by 44 per cent.

The more important aspect is that the asset quality may not deteriorate sharply. From the current 11.8 per cent gross non-performing assets (NPA) ratio in Q2 for BoB, the combined entity’s number, extrapolated on the basis of the Q2 data, works to about 12.7 per cent. 

That’s less than 1 per cent of increase in NPAs. “We seem closer to the end of the NPA recognition cycle, hence we see lower chances of a kitchen-sinking,” says analysts at Nomura.

However, considering that the three banks maintain different provision coverage ratios, with that of BoB being the highest at 70 per cent, write-offs and provisioning costs may remain high in the process of integration. But the question is how long investors should endure the pain of integration.

SBI took a year to consolidate operations with its associates. Investors of BoB could expect a similar or longer timeline for the integration process to conclude. 

The other uncertainty is the continuance of PS Jayakumar as managing director and chief executive officer of BoB after the merger. He was given a year’s extension in October 2018.

This is why brokerages, despite viewing the merger positively, haven’t raised their expectations from the BoB stock. “Integration issues and strong leadership will remain key challenges ahead,” analysts at ICICI Securities warn. Therefore, even if BoB’s valuation at 1.1x FY20 book is undemanding, experts advise investors to stay on the sidelines, until clarity emerges especially on the management front.