PSU banks: Time to cherry pick

Last Updated: Thu, Nov 22, 2012 19:40 hrs

Even as concerns over PSU banks’ asset quality and growth rates remain, experts say there are a few like BoB, OBC and Union Bank which offer a favourable risk-reward equation

Rising asset quality woes and slowing credit offtake have hit the stocks of most PSU banks over the past one year. The recently announced higher provisioning requirement by the Reserve Bank of India will also impact their earnings. However, experts believe while the falling interest rates and improvement in gross domestic product (GDP) growth will reflect positively on these banks, some PSU banks offer favourable risk-reward even in this environment.

"Historically, bank stocks and indices have correlated inversely with interest rates. Beaten down PSU banks thus, offer an investing window, despite genuine (but arguably over-rated) fears on asset quality. Despite the recent run-up, PSU bank stocks are trading close to historic low valuations (0.7-1.2 times) with return on equity (RoE) of 15-19 per cent. Further, some PSU banks also offer the comfort of decent dividend yield of four per cent,” write analysts at HDFC Securities in a recent report.

In Rs crore BoB Union Bank OBC
Net interest income 11,668 7,572 4,927
% change y-o-y 13.1 9.6 16.9
Total income 15,128 9,918 6,278
% change y-o-y 10.1 7.3 15.1
NIM (%) 2.4 2.8 2.6
Bps change y-o-y -18 - -
Net profit 5,350 2,153 1,654
% change y-o-y 6.9 20.5 44.9
Price / Book Value (x) 1.0 1.0 0.8
Return on Equity (%) 17.3 15.6 15.0
Return on Assets (%) 1.1 0.8 0.9
Net NPA (%) 0.7 1.9 1.6
All figures are estimates for FY13,                                 Source: Brokerage reports

Among the PSU bank stocks that analysts prefer include Bank of Baroda (BoB), Oriental Bank of Commerce (OBC) and Union Bank, despite the recent outperformance (see chart). While there has been some improvement in asset quality, their RoE and return on assets are better than the averages of 13-15 per cent and 0.7-0.8 per cent, respectively, for PSU banks.

Bank of Baroda
Healthy loan growth, better return ratios and inexpensive valuations make BoB a preferred stock with most brokerages. The BoB management has maintained its loan growth guidance of 1-1.5 percentage points above the banking industry growth (currently at 15.9 per cent). On the flip side, its annualised slippages rose to two per cent in the September quarter as against one per cent levels a year ago, which was reflected in higher non-performing asset (NPA) ratios. However, even at current levels, the NPA ratios are significantly lower than those of peers. “While slippages remain elevated, we believe that these will peak in FY13. BoB remains relatively more profitable amongst PSU banks with return on assets ratio of one per cent. Current valuations are not too demanding,” writes Tabassum Inamdar of Goldman Sachs Equity Research in a recent report. Inamdar has raised BoB's target price to Rs 895 (from Rs 765) implying a target multiple of 1.2 times FY14 estimated adjusted book.

Oriental Bank
OBC management is focusing on improving the bank’s three key weaknesses, namely, lower CASA deposits, higher asset quality stress and lower return ratios, which are bearing fruit. The bank’s annualised slippage rate stood at 2.3 per cent for the September quarter (lowest in the last four quarters). This metric has fallen continuously since the March 2012 quarter when it stood at 5.5 per cent. Further, the bank has managed to keep its gross and net NPAs at around three per cent and two per cent levels over the past four quarters. The management has guided for gross NPAs of 2.8 per cent by March 2013. Its net interest margins (NIMs) are also likely to improve by 10-15 basis points in the second half of FY13 aided by lower wholesale rates. In the long-run, analysts expect OBC's RoE to improve from 11 per cent in FY12 to 15 per cent in FY14.

“In recent quarters, OBC has been delivering strong recoveries, stable gross NPA and net NPA ratios as well as stable NIMs, unlike peers, leading to relatively better earnings outlook. We have factored in a 26.5 per cent earnings CAGR over FY13-14,” says Vaibhav Agrawal of Angel Broking. Most analysts remain bullish on OBC and expect gains of 18-20 per cent over one year.

Union Bank of India
Union Bank witnessed improvement in its asset quality for the quarter gone by which is reflected in a lower slippage ratio (1.8 per cent) and improving NPA ratio. Going forward, the management expects recoveries to be better and slippages to hover at around current levels, which need to be monitored.

The bank has held on to its loan growth and expects to clock in 17 per cent growth this fiscal. Union Bank had witnessed deteriorating liability franchise, disappointing asset quality and declining return ratios. This, along with weak markets, saw its stock fall from Rs 417 in October 2010 to Rs 153 in August 2012. But, things are looking better. “We are enthused by the management’s efforts to clean up the books. Asset quality woes will continue, albeit with reduced intensity. We believe current valuations of 0.9 times factor in most of the negatives,” believes Vishal Modi, analyst at HDFC Securities. The stock has risen recently to Rs 233, but given the expected improvements, investors could consider it on dips.

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