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Union Bank of India
Turning the corner
Investment rationale
Strong focus on branch expansion and CASA to help maintain margins
Management’s focus on branch expansion and investment in technology has
yielding results with the bank gaining market share in CASA deposits. Savings
deposits have averaged 20% over the last five years which should help Union
Bank (UBI) maintain its margins at current levels in a rising interest scenario.
Asset quality pains to ease in 2HFY11e
We believe that slippages for the bank are likely to stabilise in 2HFY11 after
disappointments in 1H, whereby slippages have been at INR17bn.
Management has attributed the higher than expected deterioration in asset
quality due to "one- offs' (INR4.2bn from agriculture debt relief scheme and
INR3.1bn aided by three large accounts); and is guiding slippages to
normalise to INR5-6bn per quarter going ahead. We are building in credit
costs at 85bps in FY11e and 60bps in FY12e.
Cost ratios to trend upwards due to pension liability
We expect operating costs to increase 34% YoY in FY11e to account for
higher than expected pension liability for the second pension option at
INR24bn. CI ratio is estimated to increase from 40% in FY10 to 46% in
FY12e to account for higher pension expenses.
Valuation and outlook
UBI has underperformed the broader bankex by 12% on concerns related to
asset quality and higher pension expenses. However, current valuations at
1.3 FY12e P/BV (25-30% discount to BoB and PNB) more than adequately
price these risks. We are likely to see strong rebound in return ratios in FY12e
backed by strong earnings.
We value the bank using a single state Gordon growth model arriving at a
target price of INR407/share based on 1.6x FY12e P/BV and 6.2x FY12e
PE offering 25% upside from current levels and reiterate a BUY.
Investment rationale
Strong focus on branch expansion and CASA to help maintain margins
A strong focus to grow its branch network and invest in technology has placed UBI
among few PSU banks, which have been gaining market share in CASA deposits.
Bank’s average CASA deposits have increased from ~27-28% to 32%. Although CASA
ratio at 32% is still lower than industry standards, a faster growth and market share
gains definitely augurs well for sustainability of margins in a higher interest rate
environment. We forecast calculated margins for UBI to be at 2.6% for both FY11e
and FY12e (an improvement of 25bps over FY10) resulting in strong NII growth.
Asset quality pains to ease in 2HFY11e
The bank has made it a bit of a habit of delivering disappointing results with substantial
deterioration in asset quality over the last couple of quarters. 2QFY11 has been no
different with slippages coming in at INR11bn as against market expectations of INR8bn.
Management has attributed the higher than expected deterioration in asset quality due
to "one- offs' (INR4.2bn from agriculture debt relief scheme and INR3.1bn due to three
large accounts); and is guiding slippages to normalise to INR5-6bn per quarter going
ahead. We are estimating credit costs at 85bps in FY11e and 60bps in FY12e.
Cost ratios to trend upwards due to pension liability
We are building in operating costs to increase 34% YoY in FY11e to account for
higher than expected pension liability for the second pension option at INR24bn.
Cost to income ratio for the bank is likely to increase from 40% in FY10 to 46% in
FY12e to account for the higher provisions that the bank will have to make related to
pension liability.
Valuation and outlook
While earnings growth for UBI could be muted in FY11e at 1.6%, we are likely to see
strong rebound in return ratios in FY12e backed by strong earnings. We expect earnings
to grow at 26% in FY12e driven by lower credit costs on account of stabilisation in
asset quality and margins. We are estimating credit cost to peak in FY11e to 85bps
and trend downwards to 60bps in FY12e. Further, the bank has made significant
strides on its liability franchise due to strong branch expansion with savings deposit
growth maintained at ~20% over the last five years - amongst the highest within PSU
banks. This should help UBI maintain its margins at current levels in a rising rate
scenario.
Union Bank of India has underperformed the broader bankex by 12% on concerns
related to asset quality and higher pension expenses. However, current valuations at
1.3 FY12E P/BV (25-30% discount to the BoB and PNB) more than adequately price
these risks.
We value the bank using a single state Gordon growth model arriving at a target
price of INR407/share based on 1.6 FY12e P/BV and 6.2 FY12e P/E offering 25%
upside from current levels. Key risk for the bank is higher than expected slippages in
asset quality.
We reiterate a BUY at current levels.
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