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City Union Bank
A Class Apart
City Union Bank (CUB) is a niche, SME-focused old private sector bank
with over 230 branches and a loan portfolio of US$1.8bn. Widely
acknowledged to be a conservative lender, CUB boasts a consistent
record of high profitability, superior efficiency ratios and high return
ratios (with RoAs consistently clocking above 1.5%). The stock has
recently been ‘discovered’ by institutional investors, resulting in a
sharp re-rating over the last 12 months. We believe that further
positive catalysts loom.
Key Investment Drivers
Loan book expansion to stay ahead of system: Given the lower base
and a domain advantage from lending to SMEs, CUB is likely to continue
growing its loan book faster than the banking system. CUB is looking to
quadruple its loan book while staying focused on SME lending (bread and
butter business), aiming at a 5-year loan book CAGR of ~35%.
Higher asset yields and expansion in C-D ratio to sustain net
interest margins (NIMs): With a portfolio mix skewed toward lowduration
working capital loans (60% of US$1.8bn loan book), CUB stands
apart from the rest of the domestic banking system in terms of the
duration of its asset side of the balance sheet. This is particularly beneficial
to CUB in a rising interest rate environment with the asset side getting repriced
more frequently v/s the liability side of the balance sheet (B/S).
Coupled with the fact that CUB is keen to re-calibrate deposit growth to
keep pace with deployment opportunities resulting in expansion of the
credit-deposit ratio, we expect NIMs to sustain above 3% during this rate
cycle (rising interest rate environment).
Share of secured lending offers a safety margin: CUB’s loan book
predominantly comprises secured loans (~97% of loan book) versus a
banking system with ~15-20% unsecured loans. Concomitant with the fact
that CUB lends for the creation of productive assets (very little exposure to
retail lending), this offers investors a high margin of safety. This is reflected
in the quality of the: (i) balance sheet (superior asset quality - net NPAs at
0.5%); and (ii) earnings (lower credit costs and higher recoveries).
Higher proportion of fee income to generate alpha: We believe the
key re-rating kicker would arise from sustainable fee income, as a result of
which new-generation private sector banks would emerge as the relevant
peerset for CUB. We expect CUB’s efforts on the fee income front to
account for an increasing proportion of earnings (FY11: 42% of operating
profits; FY10: 40% of operating profits) and boost RoAs further.
Newsflow on capital infusion to stimulate interest: Despite a Tier-I
ratio above 12%, CUB has passed an enabling resolution to raise Rs3bn.
Valuation, Recommendation and Outlook
At its CMP of Rs48, the stock trades at 1.7x our FY12E ABVPS of Rs28.3. We
maintain our BUY stance with a target price (TP) of Rs60. We continue to
view CUB as a longer-term multibagger. Our TP implies a 2.1x FY12E
P/ABV multiple [a 25% premium relative to 1.7x FY12E P/ABV for South Indian
Bank (SIB IN) and a 15-20% discount to larger new-generation private sector
banks]. This compares with CUB’s longer-term average P/ABV of 1.0x (since
April ‘02) and a 3-yr average P/ABV of 1.3x (since April ’08).
City Union Bank (CUB), headquartered in the temple town of
Kumbakonam in Tamil Nadu, is the oldest among old
private sector banks in India. CUB has over 230 branches
and a loan portfolio of US$1.8bn (Rs81bn). A majority of
CUB’s branches are in Tamil Nadu. CUB boasts a consistent
record of high profitability, superior efficiency ratios and
high return ratios. The bank is widely acknowledged as a
niche, SME-focused, working capital-intensive bank with a
significantly high proportion of secured lending towards
creation of productive assets.
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