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Bank of India
▲ Overweight
Previous: Neutral
BOI.BO, BOI IN
Upgrade to Overweight - Asset quality set to improve
• Upgrade to Overweight: We upgrade BOI to Overweight from Neutral
following its strong underperformance (~20% over the past three
months) and expected asset quality improvement and rebound in
profitability. Although we are cautious on PSU banks given the liquidity
situation currently, BOI’s valuation at 1.3x FY12E book looks
reasonable, with the possibility of a strong asset quality improvement.
• Asset quality to improve: With large airline exposure upgrades, we
expect asset quality to improve in the near term. Slippages have been
high and are expected to come down from current levels. This asset
quality improvement will drive a 20% drop in credit costs in FY12 and
lead to a 30-35bp improvement in ROA over FY10-12 and a ~70%
profit jump in 2H FY11, by our estimates.
• Profit growth trend divergent vs the sector: We expect BOI to report
divergent asset quality and profit growth trend over the next 3-6 months.
An upgrade of the company’s airline exposure would lead to lower
credit costs for BOI vs the sector. Also, although margins would be
under pressure over the next two quarters, margins in 3Q11 would
improve sequentially given one-offs.
• Near-term risks remain: We expect system liquidity to remain tight in
the near term, and margin pressure to remain a risk for the sector and
BOI. Also dilution risks persist given Tier-1 capital of <8.5%.
• Reasonable valuations + improving asset quality: Since 2Q10, BOI
has underperformed broader markets by ~20%, peers by 10%, and
current valuations at 1.3x FY12E look attractive (average five-year
valuations). Potential large upgrades in the near term could lead to lower
credit costs and return ratios should bounce to the sector average. We
thus upgrade BOI to Overweight with a Sep-11 price target of Rs590.
Key risks to our price target include margin pressure and possible
dilution leading to lower ROEs.
Asset quality to improve
Large upgrades in 3Q FY11: BOI’s airline exposure of Rs5.5B should be upgraded
in 3Q FY11 folllowing the restructuring of airline debt. Unlike most banks, BOI had
recognized this exposure as NPA, and hence we believe large upgrades for airline
exposure will be limited to BOI, leading to divergent asset quality trend for BOI in
this quarter vs other large PSU banks where we expect slippages to continue for this
quarter.
Overall asset quality also improving: 2Q FY11 slippages inched up following an
improvement in asset quality in 1Q FY11. Management expects slippages to come
off, and recoveries and upgrades to start to pick up in the next quarter, and that would
help lower provisioning expenses. We expect credit costs for BOI to come off from
~110bbp to ~65bp in FY12 and drive a strong ROA improvement.
Profit growth trend divergent v/s the sector
With increasing margin pressure, profit growth for the PSU banks is likely to remain
under pressure over the next 2-3 qtrs. But for BOI, significant improvement in asset
quality and lower credit costs would drive strong profit growth in 2H11. With fall in
credit costs to <1.0% we expect ~70% growth in net profit for 2H11 and ~40%
CAGR earnings growth over FY10-12E.
Return ratios to improve significantly: Higher credit costs in FY10 led to <15%
ROES. With the 2x increase in net profit expected over FY10-12 return ratios would
converge closer to peers with ROA trending above 1.0% and ROEs to >20% by
FY12 mainly driven by the improvement in credit costs.
Upgrade to Overweight
We upgrade BOI to Overweight from Neutral following the strong underperformance
(~20% over the past three months) and expected asset quality improvement and
rebound in profitability. Although we are cautious on PSU banks given the liquidity
situation currently, valuations at 1.3x FY12E book look reasonable, with the
possibility of strong asset quality improvement. We adjust our estimates marginally
with no material change to our FY12/FY13 numbers.
Valuations reasonable post underperformance: Since 2Q FY10, BOI has
underperformed broader markets by ~20%, peers by 10%, and current valuations at
1.3x FY12E look attractive given the asset quality improvement.
Risks: (1) We expect system liquidity to remain tight in the near term and margin
pressure to remain a risk for the sector and BOI. Margins should improve in 3Q
FY11 for BOI but we expect margin contraction in 1HCY11 inline with the sector.
(2) Risk of dilution given low levels of capital adequacy.
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