SBI: 2Q FY11 results a mixed bag: HSBC

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State Bank of India (SBI)
UW: 2Q FY11 results a mixed bag
 2Q profits below our and street estimates; higher loan loss
provisions and one-offs offset NIM gains
 Excluding one-off additions from State Bank of Indore,
slippages remained high, dragging profits down
 Reiterate UW (remove V-flag), raise target price to INR2,800
(from INR2,169), implying a potential return of -13%




2QFY11 results: SBI posted flat profits y-o-y at INR25bn, 19% below and 15% below
street estimates. Although the bank delivered better-than-expected margins and higher fee
income growth, the gains were offset by continuing asset quality deterioration, provisioning
requirements on employee gratuities and efforts to meet RBI’s 70% coverage norms.

Key themes: SBI merged with State Bank of Indore in 2Q, almost entirely supporting its loan
book growth of 4% q-o-q. A higher CASA mix, along with peak LDR of 80%, helped margins
expand 25bps q-o-q. Asset quality slippages worsened even after excluding the one-off from
the merger, emanating mainly from agri, international, SME and restructured portfolios.

Expectations and outlook: We believe SBI key earnings’ upsides have played out in 1H
with its margins likely to have peaked and further improvement in the cost/income ratio
appearing difficult, in addition to delinquencies and provisioning pressure continuing to
meet the RBI deadline for 70% provision cover by Sep-11. Beyond FY11, we expect fully
diluted earnings CAGR of 22%, driven mainly by asset quality risks abating. We fine-tune
our estimates but SBI’s return ratios remain below peers, along with multiples at a
premium to peers, which are likely to act as a drag on stock performance.

Valuation and risks: Our revised 12-month target price is INR2,800 from INR2,169,
which implies a 13% negative potential return to the current market price. Accordingly we
maintain our Underweight rating, removing the volatility flag. We continue to value SBI
using a weighted average combination of PE, PB and economic profit model (EPM)
methodologies. For PE and PB we set our target multiples after examining historical
trading patterns and hence use 24-month forward EPS and BV in our valuation.

Accordingly, we value SBI at 11.7x PE and 1.8x PB based on 24-month forward EPS and
BPS. Key upside risks to our rating and estimates: (1) Margins remaining high at
current levels, (2) operating expenses declining further, and (3) delinquencies declining
more than expectations.