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Bank of India: Asset quality stabilising,
upgrade to Hold - Deutsche bank
U/g to Hold with new TP at Rs460, fairly valued relative to fundamentals
We upgrade BoI to Hold from Sell after adjusting target price to Rs460 from Rs450
following earnings revision and abatement of credit costs. We believe that the
bank, which suffered early in the credit cycle, has the worst behind it, and has also
managed to strengthen margins towards a better RoA. However, risks do remain -
margins could correct, occasional accidents on credit quality can't be precluded
and large pension provisions need to be made.
Q3FY11 result – NIM & NPL surprise positively
Net profit at INR6.53bn was up 61% YoY and in line with our estimates. While NII
and non-interest income were both ahead of estimates, this was offset by higherthan-estimated operating expenses and provisions. NIM expanded by 30bps QoQ
as loans repriced faster than deposits. There was one-off provision of INR2.02bn
towards provision for overseas derivative contracts. NIM expansion was also
helped by improvement in CASA (low-cost) ratio. Asset quality surprised positively
with slippages declining sharply and strong recoveries leading to decline in G NPL.
Credit costs likely to fall, but margins may remain volatile
BoI underperformed for most part of 2010 in the aftermath of sharp asset quality
deterioration, which appears to have largely run its course. The testing of
restructured book moratorium expiration also should have nearly completed, as
slippages from this book already reached 21% and hence should not have much
further to go. Loan growth has also moderated to ~22% over FY10-11E compared
to 30%+ CAGR in the three prior years. But NIM is likely to contract as deposits
reprice over the next two to three quarters, and QoQ movement is very volatile.
P/BV-ROE valuation; lower credit costs the upside risk and lower margins
the downside risk
We value Bank of India on a single-stage Gordon growth model (P/B=ROE-g/COEg). Key downside is lower margins due to deposit re-pricing and main upside is a
greater-than-expected improvement in credit costs on account of a larger fall in
incremental slippages
Investment thesis
Outlook
Bank of India's aggressive strategy in rapidly expanding its loan book in the few years prior to
the credit crisis resulted in damage to its credit quality and margins. However, we believe
this phase has come closer to an end as slippages have been reined in and the restructured
book has also largely seasoned. Credit costs could thus decline from current levels. This in
turn could mean that loan/fee growth which has been subdued of late has the potential to
recover at the margin. However, the recovered NIMs could contract as deposits re-price in
the next year or so, putting pressure on RoA again. The bank also has a significant amount of
provisioning left to do on pension liabilities, whose amount is currently very uncertain and
runs the risk of an overshoot, as has happened with some other state banks. On account of
the balance between the risks and reward and valuations correspondingly reflecting that, we
rate the stock a Hold.
Valuation
The bank is valued on a single-stage Gordon Growth model (RoE - g)/(CoE - g), which we
believe is an appropriate model for a relatively steady-growth public sector bank.
Assumptions: schematic RoE estimate 16.2%, FY12E RoE 19.0%, thus a blended RoE of
16.9% (25% weight to FY12E and 75% to schematic), cost of equity of 13.17% (using
Deutsche Bank estimates), and perpetual growth rate 5% (expected long-term nominal GDP
growth for developed economies). Using these values in the Gordon growth formula we get
a target multiple of 1.46x, which we multiply by Dec '12E adj. BV to get to our target price.
Risks
The key upside risks are: 1) Lower credit costs than estimated if the bank were to report
lower incremental slippages – this number has been very critical for Bank of India in the last
two years; 2) Loan growth ahead of the system loan growth - BoI has broadly been growing
in line with the system. Downside risks are: 1) lower margins as deposits re-price, important
specifically for BoI as they have only recently managed to pick margins up and the low-cost
deposit ratio is not very high; 2) provisions for the second pension option going higher than
our estimates and bank guidance (the latter is based on a preliminary estimate by the bank).
Q3FY11 results – higher than estimated
Bank of India reported net profit of INR 6.5bn, broadly in line with our estimates. Non-interest
income was up 13.4% YoY and ~22% ahead of our estimates driven by higher forex and
commission income.
Earnings, rating and valuations
Earnings revision
We are raising our FY11E/FY12E/FY13E for net profit by 6.6%/6.4%/11.8% by factoring in
higher net interest income and lower NPL provisions.
Single-stage Gordon growth method of valuation
We value Bank of India on single-stage Gordon growth model P/BV = (RoE – g)/(CoE – g).
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Bank of India: Asset quality stabilising,
upgrade to Hold - Deutsche bank
U/g to Hold with new TP at Rs460, fairly valued relative to fundamentals
We upgrade BoI to Hold from Sell after adjusting target price to Rs460 from Rs450
following earnings revision and abatement of credit costs. We believe that the
bank, which suffered early in the credit cycle, has the worst behind it, and has also
managed to strengthen margins towards a better RoA. However, risks do remain -
margins could correct, occasional accidents on credit quality can't be precluded
and large pension provisions need to be made.
Q3FY11 result – NIM & NPL surprise positively
Net profit at INR6.53bn was up 61% YoY and in line with our estimates. While NII
and non-interest income were both ahead of estimates, this was offset by higherthan-estimated operating expenses and provisions. NIM expanded by 30bps QoQ
as loans repriced faster than deposits. There was one-off provision of INR2.02bn
towards provision for overseas derivative contracts. NIM expansion was also
helped by improvement in CASA (low-cost) ratio. Asset quality surprised positively
with slippages declining sharply and strong recoveries leading to decline in G NPL.
Credit costs likely to fall, but margins may remain volatile
BoI underperformed for most part of 2010 in the aftermath of sharp asset quality
deterioration, which appears to have largely run its course. The testing of
restructured book moratorium expiration also should have nearly completed, as
slippages from this book already reached 21% and hence should not have much
further to go. Loan growth has also moderated to ~22% over FY10-11E compared
to 30%+ CAGR in the three prior years. But NIM is likely to contract as deposits
reprice over the next two to three quarters, and QoQ movement is very volatile.
P/BV-ROE valuation; lower credit costs the upside risk and lower margins
the downside risk
We value Bank of India on a single-stage Gordon growth model (P/B=ROE-g/COEg). Key downside is lower margins due to deposit re-pricing and main upside is a
greater-than-expected improvement in credit costs on account of a larger fall in
incremental slippages
Investment thesis
Outlook
Bank of India's aggressive strategy in rapidly expanding its loan book in the few years prior to
the credit crisis resulted in damage to its credit quality and margins. However, we believe
this phase has come closer to an end as slippages have been reined in and the restructured
book has also largely seasoned. Credit costs could thus decline from current levels. This in
turn could mean that loan/fee growth which has been subdued of late has the potential to
recover at the margin. However, the recovered NIMs could contract as deposits re-price in
the next year or so, putting pressure on RoA again. The bank also has a significant amount of
provisioning left to do on pension liabilities, whose amount is currently very uncertain and
runs the risk of an overshoot, as has happened with some other state banks. On account of
the balance between the risks and reward and valuations correspondingly reflecting that, we
rate the stock a Hold.
Valuation
The bank is valued on a single-stage Gordon Growth model (RoE - g)/(CoE - g), which we
believe is an appropriate model for a relatively steady-growth public sector bank.
Assumptions: schematic RoE estimate 16.2%, FY12E RoE 19.0%, thus a blended RoE of
16.9% (25% weight to FY12E and 75% to schematic), cost of equity of 13.17% (using
Deutsche Bank estimates), and perpetual growth rate 5% (expected long-term nominal GDP
growth for developed economies). Using these values in the Gordon growth formula we get
a target multiple of 1.46x, which we multiply by Dec '12E adj. BV to get to our target price.
Risks
The key upside risks are: 1) Lower credit costs than estimated if the bank were to report
lower incremental slippages – this number has been very critical for Bank of India in the last
two years; 2) Loan growth ahead of the system loan growth - BoI has broadly been growing
in line with the system. Downside risks are: 1) lower margins as deposits re-price, important
specifically for BoI as they have only recently managed to pick margins up and the low-cost
deposit ratio is not very high; 2) provisions for the second pension option going higher than
our estimates and bank guidance (the latter is based on a preliminary estimate by the bank).
Q3FY11 results – higher than estimated
Bank of India reported net profit of INR 6.5bn, broadly in line with our estimates. Non-interest
income was up 13.4% YoY and ~22% ahead of our estimates driven by higher forex and
commission income.
Earnings, rating and valuations
Earnings revision
We are raising our FY11E/FY12E/FY13E for net profit by 6.6%/6.4%/11.8% by factoring in
higher net interest income and lower NPL provisions.
Single-stage Gordon growth method of valuation
We value Bank of India on single-stage Gordon growth model P/BV = (RoE – g)/(CoE – g).
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