Macquire research: Bank of Baroda: Downgrade to Neutral

Bank of Baroda
Downgrade to Neutral
Event
􀂃 Downgrade to Neutral on valuations: We downgrade BOB to Neutral from
Outperform and maintain our TP at Rs850. BOB is now trading at its all-time
high valuations and the risk-reward is unfavourable at this price, in our view.
Impact
􀂃 Near-term headwinds on margins and loan growth: With deposit rates
hiked sharply and base rates untouched, coupled with the slowdown in loan
growth to 20% over the course of the year from 30% in 1QFY11, we expect
NIMs to be under pressure in the near term.
􀂃 The bank has not provided for pensions: Some of its larger peers have
already prudentially provided, or at least estimated, pension liabilities (second
option), whereas BOB has yet to come out with an actuarial estimate.
Consequently, operating expenses have more or less remained flat across
several quarters to date, which is unsustainable, in our view. We have
conservatively factored in a higher cost-income ratio of 46% for FY11E, up
200bps YoY. The overall impact due to pensions could be as high as 10% of
BOB’s net worth, if we merely try to extrapolate the numbers given by its
peers.
􀂃 International business profitability under pressure: BOB’s overseas
business, which contributes 24% of overall business and traditionally has
much higher return ratios than its domestic banking business (mainly due to
lower operating expenses and higher fee-based income), is under pressure.
ROA and ROE of this business are sub-1% and 17%, respectively, which are
lower than the steady-state ROE of 20%+ from this business. Weak global
markets are indeed taking a toll on its margins, fee income and asset quality.
􀂃 BOB remains one of the best-run PSU banks: Under the leadership of
Chairman and Managing Director, Mr. Mallya, BOB indeed has seen a
commendable turnaround in overall profitability, with return ratios improving.
The current CMD is slated to be in office till Nov-12. Management stability is
an encouraging factor.
Earnings and target price revision
􀂃 No impact.
Price catalyst
􀂃 12-month price target: Rs850.00 based on a Gordon Growth methodology.
􀂃 Catalyst: Loan growth slowdown in 2QFY11, margin compression in 3QFY11
Action and recommendation
􀂃 BOB continues to be one of our favourites amongst PSU banks. We would
recommend investors to add BOB on corrections.