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City Union Bank: Impressive track record and superior asset quality
Investment arguments
Impressive track record over a century: City Union Bank (CUB) is one of the
oldest and well managed old private sector banks and has had a consistent track
record, of profits and dividends during most of the years in its over 100 years of
operations. Over the last five years, CUB has grown its net profits by 30 per cent
(CAGR) while its business has grown by 27 per cent (CAGR). The bank also scores
above most of its peers on operational parameters, having an ROA of 1.98 per cent
and ROE of 27.31 per cent in Q2FY11. CUB has been aggressively growing its
branch network - currently, it has 229 branches and the management has plans to
grow its branch network to 500 branches over the next 3 years.
We expect consolidation of Old Private Sector Banks to continue: While the
Old Private Sector Banks (OPSBs), like CUB, lack identifiable promoters, we firmly
believe that the issue of new banking licenses are likely to be quite restricted.
Further, we expect that even if new banking licenses are issued, it would take a
minimum of 1-2 years for the new players to start and scale up their business.
Hence, we believe there is further scope for significant consolidation in this space
by means of either an outright takeover or by acquiring a sizeable stake. We expect
CUB, being one of the most efficient banks in the OPSB space, to be a beneficiary of
expected further consolidation process. It is worth noting that L&T Capital Holdings
already holds a 4.8 per cent stake in CUB.
Steady progress in asset quality: CUB has witnessed a consistent improvement
in its asset quality over the years. Its Gross NPAs (Non-performing assets) have
come down from as high as 5.9% in March 2005 to around 1.3% in September 2010.
Net NPA levels have been brought down to mere 0.5% in September 2010 from 3.4%
in March 2005. CUB primarily lends to SMEs (Small & Medium Enterprises), with
nearly 32% of its advances going to SMEs, as on September 30, 2010. The loan book
of the company is well diversified and CUB has built good relationships with SMEs
over the decades. Its almost century-old relationships with the entrepreneurs of
SMEs in the state of Tamil Nadu, has enabled it to improve its asset quality. Also,
the fact that the customer focus of CUB is largely on the SMEs will drive its asset
growth in a significant manner in the future.
CUB stock, available at attractive valuation: CUB stock price after hitting a high
of Rs.53.90, has corrected about 19 per cent in the last one month. This stock is
available at attractive valuation of 1.6x its FY12E Adj. BV of Rs. 27.5/. An analysis of
some of the recent M&A deals in the OPSB segment, we find that such deals were
done at much higher valuations than what some of the old private sector banks, like
CUB, are enjoying at presently. A case in point being the acquisition of Bank of
Rajasthan, at 5.5x its book value, by ICICI Bank in May 2010. Before that, in 2008,
HDFC Bank had acquired Centurion Bank of Punjab at 4.5x its book value. We
believe that CUB might eventually be a significant beneficiary of anticipated further
consolidation process in the OPSB segment.
Risk to our view
Any significant slow down in the industrial economy could increase its NPAs and
thereby impact its profitability adversely.
Valuation and Recommendation
We believe that the medium to long term prospects of the banking sector remain
strong as India’s GDP is expected to grow at 8% +, over the next few years at least.
This improved growth prospects augur well for the banking sector which has
enjoyed a credit multiplier of about 3x over GDP growth rate in the past. CUB has
had an impressive track record and has seen a consistent improvement in its
growth and asset quality over the last five years. It has also improved its operational
efficiency and employee productivity significantly over the years. Considering CUB’s
impressive operational performance, attractive valuation and further opportunity for
consolidation process in the OPSB segment, we recommend a BUY on the stock
which currently trades at 1.6x FY12E Adj. BV of Rs. 27.5/, with a fair value of Rs.
60/, based on a valuation of 2.1x FY12E Adj. BV.
Analysis
CUB: Posts consistent improvement in asset quality
With consistent efforts, CUB has managed to bring about a significant improvement in its asset quality which is evident from the
fact that the company’s Gross NPAs have come down from 5.9% in March 2005 to 1.3% in September 2010. Net NPA levels have
also been brought down to 0.5% in September 2010 from 3.4% in March 2005. Its focus on SMEs and ability to manage its
relationships with SMEs well, has helped it to keep NPAs at very low levels. A sector-wise analysis of CUB’s NPAs suggests that
the ratio of NPAs to Total Advances in the industrial sector (micro & small, medium and large) is the lowest at 0.83 per cent.
CUB has seen a consistent improvement in most of the operational parameters leading to higher efficiency in operations. This is
evident from the uptrend witnessed in operational parameters like business per employee and profit per employee. While the
former has little more than doubled from Rs. 34 mn in March 2006 to about Rs. 72 mn in September 2010, the profit per
employee has exactly doubled from Rs.0.4 mn to Rs. 0.8 mn during the same period.
CUB Outperformed the Bankex in the last one year
The thematic idea of old private sector banks has played out well over the last one year. An analysis of the performance of CUB
vis-à-vis the Bankex throws up an interesting observation. While the Bankex has moved up by only 27% in the last one year, the
stock of CUB has outperformed the Bankex by a wide margin, having given a return of 66% in the last one year. Most of the
other old private sector banks like Karur Vysya Bank, South Indian Bank, Federal Bank, etc, have also outperformed the Bankex
over the last one year having given returns in the range of 50% - 80%. Considering lack of identifiable promoters and
opportunities for further consolidation, we believe that the stocks of OPSB segment will continue to outperform the overall
banking sector index going forward.
CUB: Available at attractive valuations
The old private sector banking theme has been in focus for a while and more consolidation is expected to happen in the
banking sector going forward. The recent acquisition of Bank of Rajasthan at 5.5x its Book Value by ICICI Bank has set the tone
for future consolidation in this space. ICICI Bank had earlier acquired Bank of Madura and Sangli Bank, while HDFC Bank had
acquired Times Bank Ltd and Centurion Bank of Punjab, highlighting the growing pace of consolidation which has become
desirable strategy for the purpose of increasing their scale as well as geographical reach. With 200 of its 229 branches located
in South India, CUB becomes an ideal choice for outright consolidation process for bigger banks looking at expanding their
presence in Southern India. Even its plans to open 55 new branches over the next one year are heavily skewed towards South
India. Tamil Nadu alone is expected to see an addition of 35 branches. A peer comparison, with respect to operational and
valuation parameters, among old private sector banks shows that CUB is one of the better banks in the old private sector
banking space, currently trading at 1.6x FY12E Adj. BV of Rs. 27.5 per share.
Company Profile
City Union Bank (CUB) was incorporated as a limited company on October 31, 1904. The bank has come a long way and
currently operates 229 branches spread across the southern and western states of India. It is well capitalized, having a CAR of
13.41% as on Sep 30, 2010. CUB’s business has witnessed a CAGR of 27% over the last five years. Major institutional investors
in CUB include LIC (4.97%) and L&T Capital Holdings (4.78%). CUB lends to diverse sectors including textiles, iron and steel,
construction, paper and food processing among others. The company’s focus has been the small and medium enterprises and
advances to the SME sector stood at 32% in September 2010.
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