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State Bank of India
Entering a Cyclically Tough Spot; EW
What's Changed
Rating Overweight to Equal-weight
Price Target Rs3,290.00 to Rs3,000.00
% EPS Chg F2011e/12e/13e -2% / -8% / -8%
We are changing rating to EW. NIM compression in
the near term is likely to be greater than our
previous estimates. This, coupled with recent
performance, drives our view.
Our structural view on SBI is intact: Our bullish view
has been premised on structural improvements (gain in
retail deposit base, fees income, improving core
profitability). For long-term investors, we continue to
believe that SBI remains a good stock to own as it is still
doing well on these parameters. However, from a
cyclical perspective, the stock is likely entering a tough
period and will likely lag in the near term.
NIM compression can be meaningful: We had
expected NIMs to come off gradually, by 40bp over the
next four quarters. However, the pace of increase in
system deposits implies that the NIM compression can
be greater and could be front-loaded as well.
Asset yield increase will be reflected in NIMs by end of
F4Q11 and deposit costs will rise as repricing occurs.
Plus, the incremental credit-deposit ratio (since deposit
rate hikes started) has slowed. SBI was a big beneficiary
of NIM expansion and could give some of that up over
two quarters. We are now building in a NIM compression
of 50bp by end-F2012 (largely front-loaded), driving the
change in our estimates.
Valuation is unlikely to support, near term, if
earnings slow: SBI has been the best-performing
large-cap Indian bank in our coverage over 12 months.
At 11.4x F2012e core earnings, it is not cheap, unlike
other smaller SOE banks. Plus, it will likely see bigger
NIM compression than private banks. Among large cap
Indian banks, we prefer HDFC Bank and ICICI Bank.
Investment Thesis
• Largest bank in India with a 24%
market share in loans.
• Structurally remains the stock to own
among Indian and regional banks –
given improvement in retail deposit
franchise (CASA ratio at 48%), fee
income growth, and improving core
fee income profitability.
• Margins, which are at peak levels,
could see cyclical pressure owing to
rising funding costs and loan/deposit
ratio normalization.
• Stock has seen strong performance in
the past 12 months.
• Trading at 11.4x F2012e core
earnings. On core book value, it is
trading at 1.6x F2012e.
Key Value Drivers
• Loan growth
• Margin progression
• Fee income
• Credit costs
• Life insurance valuation/market share
Potential Catalysts
• System-wide loan / deposit growth
trends
• Margin progression
• Deposit rate trends in India
• Impaired loan trends.
Key risks
• Greater-than-expected margin
compression
• Credit costs stay higher for longer
• Lower-than-expected loan growth
• Impaired loan creation re-accelerates
• Very sharp rise in long bond yields
Investment Case
Moving to Equal-weight
We are moving to Equal-weight on SBI following the strong
outperformance and increased macro uncertainty. We
continue to believe that from a longer-term perspective, SBI
remains the stock to own among Indian and regional banks
given the strength of its liability franchise and improving
profitability trends. However, increased macro uncertainty
could weigh on near-term earnings progression (to a greater
extent than our previous estimates); hence, we are moving to
Equal-weight.
Performance over the Past 18 Months Driven by Structural
and Cyclical Factors
SBI has seen strong outperformance over the past year and a
half. In our view, the outperformance was driven by a
combination of: 1) structural factors – savings account
market share gains and fee income traction; and 2) cyclical
factors – better-than-expected revenue progression (owing to
expanding margins) more than offsetting concerns on asset
quality. In fact, NIM progression has been far stronger than our
estimates.
However, we are likely to enter a phase of one or two quarters
where NIMs will compress, and pressure on NIMs could be
higher than market expectations. Margins can rise more than
expected, and can mean revert quicker than expected.
We had been building in about 40bp of NIM compression over
F1202. However, with deposit growth being fairly strong
recently – as rates have risen – and incremental credit/deposit
ratio falling to about 63% since mid-December (when deposit
rate hikes started), we now believe NIM compression will be
higher and faster. Moreover, asset repricing is now behind the
company, and funding costs will likely increase as we move
ahead.
Margin Expansion Has Been One of the Key Drivers of
Profitability Improvement
SBI’s net interest margin has expanded by over 120bp from
2.3% as of Jun-09 to 3.5% as of Dec-10. This is sharper than
that seen for most other banks in the system (Exhibit 6), and
has been the result of both structural and cyclical factors
working especially well for SBI (Exhibit 7). We discuss these
factors in greater detail in the following section.
Structural factors: A large part of the margin expansion was
driven by improvement in liability mix as the bank wound down
high-cost bulk deposits and improved CASA proportion. The
bank has shed high-cost deposits and the outstanding balance
has come off to Rs40bn (4.6% of current deposit base) from the
peak of 16% of deposit base (as of Dec-08). CASA ratio has
moved up from 38.5% as of Jun-09 to 48.2% as of Dec-10. SBI
achieved this improvement by giving up market share in
system-wide term deposits but gaining market share in savings
account deposits.
Cyclical factors: The other factor driving improvement was
the normalization and the subsequent increase in loan/deposit
ratio. While this was a system-wide phenomenon, it was more
acute in the case of SBI (see Exhibit 9). SBI’s domestic LD ratio
moved up to 77% in December 2010 from 65% as of Jun-09,
while the system’s LD ratio improved to 76% from 70%. This
helped the bank move its asset mix toward higher-yield assets
– loans – from lower-yield investments
The more recent margin expansion has been driven by the fact
that SBI (and other banks) raised both deposit and lending
rates simultaneously in the initial part of the rate hike cycle.
Given the nature of their balance sheets, loan re-pricing filters
through faster-than-deposit re-pricing for Indian banks
contributed to the expansion in margins.
Cyclical Benefit to Margin to Unwind; Increased Macro
Headwinds Add to the uncertainty
Clearly, SBI’s current peak net interest margin of 3.5% is not
likely to sustain, and we had built some margin compression
into our estimates. However, increased macro headwinds are
likely to weigh on the assumptions; hence, we have taken
down our margin assumptions for F2012. In the following
section, we discuss the outlook for each of the key levers for
margin from a cyclical perspective.
1) Cost of deposits: Although SBI has raised retail deposit
rates by 275bp since June 2010 to a near-peak level of 9.25%,
the full impact of this has not yet filtered through into deposit
costs. Typically, the term deposits for Indian banks have a oneyear
maturity and are fixed rate in nature – and so only
maturing deposits / incremental deposit creation are affected
by the change in deposit costs. This implies that the increased
cost of deposits tends to filter through with a six- to nine-month
lag.
In this cycle, SBI had the additional benefit of high-cost
deposits raised in the 2008 cycle rolling over. Indeed, it still has
about Rs400bn (~9% of term deposits) of these high-cost
deposits that are due to rollover in the coming six months.
As Exhibit 11 indicates, if retail deposits rates remain around
elevated levels, the cost of deposits is likely to move up as the
higher deposit costs filter through in the coming quarters (of
course, the old high cost deposits rolling over could provide
some buffer).
Price Target Discussion for SBI
We arrive at our revised price target of Rs3,000 using a
probability-weighted sum-of-the-parts method as follows:
• Base case value – 60% weighting (unchanged): Down 8%
from Rs3,450 to Rs3,160 per share.
• Bear case value – 20% weighting (unchanged): Down 9%
from Rs1,900 to Rs1,735 per share.
• Bull case value – 20% weighting (unchanged): Down 10%
from Rs4,200 to Rs3,800 per share.
The key driver of our price target change is our earnings
revisions. We have lowered our EPS forecasts for F2011,
F2012 and F2013 by 2%, 8%, and 8%, respectively. As
mentioned earlier, the earnings changes are driven by margin
compression.
In our numbers, we continue to assume that the potential
additional liability on account of the shift in pension base at
Rs50bn to be amortized over a period of five years beginning in
F2012. We also incorporate the full gratuity-related provision in
F2011 itself (rather than amortizing over five years – as has
been allowed by the Central Bank). There is a chance that the
bank may make additional pension liability provisions in F2011
itself – but this could be partially offset by reversal of existing
gratuity provisions. We are not making changes to our
assumptions since the exact accounting is not certain as yet.
The two components to SBI from a valuation perspective are
the banking and life insurance businesses. We value them on
the following basis:
Consolidated banking business: We value the banking
entities using a three-phase residual income model – a
five-year high growth period and a 10-year maturity period,
followed by a declining period.
• Base case value – 60% weighting (unchanged): Down 9%
from Rs3,315 to Rs3,025 per share.
• Bear case value – 20% weighting (unchanged): Down 9%
from Rs1,815 to Rs1,650 per share.
• Bull case value – 20% weighting (unchanged): Down 10%
from Rs4,000 to Rs3,600 per share.
Life insurance business: For this we use an appraised value
method. We compute the embedded value at Rs32.5bn. To
this, we add value of new business to get a base-case value for
the life business of Rs135 per share.
Risks to Our Price Target
Key downside risks to our price target include slower-thanexpected
loan growth, sharp compression in NIMs, and
significant deterioration in asset quality (restructured loans
slippages).
Upside risks include: fee income being stronger than
expectations and credit costs being lower than expectations
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
State Bank of India
Entering a Cyclically Tough Spot; EW
What's Changed
Rating Overweight to Equal-weight
Price Target Rs3,290.00 to Rs3,000.00
% EPS Chg F2011e/12e/13e -2% / -8% / -8%
We are changing rating to EW. NIM compression in
the near term is likely to be greater than our
previous estimates. This, coupled with recent
performance, drives our view.
Our structural view on SBI is intact: Our bullish view
retail deposit base, fees income, improving core
profitability). For long-term investors, we continue to
believe that SBI remains a good stock to own as it is still
doing well on these parameters. However, from a
cyclical perspective, the stock is likely entering a tough
period and will likely lag in the near term.
NIM compression can be meaningful: We had
expected NIMs to come off gradually, by 40bp over the
next four quarters. However, the pace of increase in
system deposits implies that the NIM compression can
be greater and could be front-loaded as well.
Asset yield increase will be reflected in NIMs by end of
F4Q11 and deposit costs will rise as repricing occurs.
Plus, the incremental credit-deposit ratio (since deposit
rate hikes started) has slowed. SBI was a big beneficiary
of NIM expansion and could give some of that up over
two quarters. We are now building in a NIM compression
of 50bp by end-F2012 (largely front-loaded), driving the
change in our estimates.
Valuation is unlikely to support, near term, if
earnings slow: SBI has been the best-performing
large-cap Indian bank in our coverage over 12 months.
At 11.4x F2012e core earnings, it is not cheap, unlike
other smaller SOE banks. Plus, it will likely see bigger
NIM compression than private banks. Among large cap
Indian banks, we prefer HDFC Bank and ICICI Bank.
Investment Thesis
• Largest bank in India with a 24%
market share in loans.
• Structurally remains the stock to own
among Indian and regional banks –
given improvement in retail deposit
franchise (CASA ratio at 48%), fee
income growth, and improving core
fee income profitability.
• Margins, which are at peak levels,
could see cyclical pressure owing to
rising funding costs and loan/deposit
ratio normalization.
• Stock has seen strong performance in
the past 12 months.
• Trading at 11.4x F2012e core
earnings. On core book value, it is
trading at 1.6x F2012e.
Key Value Drivers
• Loan growth
• Margin progression
• Fee income
• Credit costs
• Life insurance valuation/market share
Potential Catalysts
• System-wide loan / deposit growth
trends
• Margin progression
• Deposit rate trends in India
• Impaired loan trends.
Key risks
• Greater-than-expected margin
compression
• Credit costs stay higher for longer
• Lower-than-expected loan growth
• Impaired loan creation re-accelerates
• Very sharp rise in long bond yields
Investment Case
Moving to Equal-weight
We are moving to Equal-weight on SBI following the strong
outperformance and increased macro uncertainty. We
continue to believe that from a longer-term perspective, SBI
remains the stock to own among Indian and regional banks
given the strength of its liability franchise and improving
profitability trends. However, increased macro uncertainty
could weigh on near-term earnings progression (to a greater
extent than our previous estimates); hence, we are moving to
Equal-weight.
Performance over the Past 18 Months Driven by Structural
and Cyclical Factors
SBI has seen strong outperformance over the past year and a
half. In our view, the outperformance was driven by a
combination of: 1) structural factors – savings account
market share gains and fee income traction; and 2) cyclical
factors – better-than-expected revenue progression (owing to
expanding margins) more than offsetting concerns on asset
quality. In fact, NIM progression has been far stronger than our
estimates.
However, we are likely to enter a phase of one or two quarters
where NIMs will compress, and pressure on NIMs could be
higher than market expectations. Margins can rise more than
expected, and can mean revert quicker than expected.
We had been building in about 40bp of NIM compression over
F1202. However, with deposit growth being fairly strong
recently – as rates have risen – and incremental credit/deposit
ratio falling to about 63% since mid-December (when deposit
rate hikes started), we now believe NIM compression will be
higher and faster. Moreover, asset repricing is now behind the
company, and funding costs will likely increase as we move
ahead.
Margin Expansion Has Been One of the Key Drivers of
Profitability Improvement
SBI’s net interest margin has expanded by over 120bp from
2.3% as of Jun-09 to 3.5% as of Dec-10. This is sharper than
that seen for most other banks in the system (Exhibit 6), and
has been the result of both structural and cyclical factors
working especially well for SBI (Exhibit 7). We discuss these
factors in greater detail in the following section.
Structural factors: A large part of the margin expansion was
driven by improvement in liability mix as the bank wound down
high-cost bulk deposits and improved CASA proportion. The
bank has shed high-cost deposits and the outstanding balance
has come off to Rs40bn (4.6% of current deposit base) from the
peak of 16% of deposit base (as of Dec-08). CASA ratio has
moved up from 38.5% as of Jun-09 to 48.2% as of Dec-10. SBI
achieved this improvement by giving up market share in
system-wide term deposits but gaining market share in savings
account deposits.
Cyclical factors: The other factor driving improvement was
the normalization and the subsequent increase in loan/deposit
ratio. While this was a system-wide phenomenon, it was more
acute in the case of SBI (see Exhibit 9). SBI’s domestic LD ratio
moved up to 77% in December 2010 from 65% as of Jun-09,
while the system’s LD ratio improved to 76% from 70%. This
helped the bank move its asset mix toward higher-yield assets
– loans – from lower-yield investments
The more recent margin expansion has been driven by the fact
that SBI (and other banks) raised both deposit and lending
rates simultaneously in the initial part of the rate hike cycle.
Given the nature of their balance sheets, loan re-pricing filters
through faster-than-deposit re-pricing for Indian banks
contributed to the expansion in margins.
Cyclical Benefit to Margin to Unwind; Increased Macro
Headwinds Add to the uncertainty
Clearly, SBI’s current peak net interest margin of 3.5% is not
likely to sustain, and we had built some margin compression
into our estimates. However, increased macro headwinds are
likely to weigh on the assumptions; hence, we have taken
down our margin assumptions for F2012. In the following
section, we discuss the outlook for each of the key levers for
margin from a cyclical perspective.
1) Cost of deposits: Although SBI has raised retail deposit
rates by 275bp since June 2010 to a near-peak level of 9.25%,
the full impact of this has not yet filtered through into deposit
costs. Typically, the term deposits for Indian banks have a oneyear
maturity and are fixed rate in nature – and so only
maturing deposits / incremental deposit creation are affected
by the change in deposit costs. This implies that the increased
cost of deposits tends to filter through with a six- to nine-month
lag.
In this cycle, SBI had the additional benefit of high-cost
deposits raised in the 2008 cycle rolling over. Indeed, it still has
about Rs400bn (~9% of term deposits) of these high-cost
deposits that are due to rollover in the coming six months.
As Exhibit 11 indicates, if retail deposits rates remain around
elevated levels, the cost of deposits is likely to move up as the
higher deposit costs filter through in the coming quarters (of
course, the old high cost deposits rolling over could provide
some buffer).
Price Target Discussion for SBI
We arrive at our revised price target of Rs3,000 using a
probability-weighted sum-of-the-parts method as follows:
• Base case value – 60% weighting (unchanged): Down 8%
from Rs3,450 to Rs3,160 per share.
• Bear case value – 20% weighting (unchanged): Down 9%
from Rs1,900 to Rs1,735 per share.
• Bull case value – 20% weighting (unchanged): Down 10%
from Rs4,200 to Rs3,800 per share.
The key driver of our price target change is our earnings
revisions. We have lowered our EPS forecasts for F2011,
F2012 and F2013 by 2%, 8%, and 8%, respectively. As
mentioned earlier, the earnings changes are driven by margin
compression.
In our numbers, we continue to assume that the potential
additional liability on account of the shift in pension base at
Rs50bn to be amortized over a period of five years beginning in
F2012. We also incorporate the full gratuity-related provision in
F2011 itself (rather than amortizing over five years – as has
been allowed by the Central Bank). There is a chance that the
bank may make additional pension liability provisions in F2011
itself – but this could be partially offset by reversal of existing
gratuity provisions. We are not making changes to our
assumptions since the exact accounting is not certain as yet.
The two components to SBI from a valuation perspective are
the banking and life insurance businesses. We value them on
the following basis:
Consolidated banking business: We value the banking
entities using a three-phase residual income model – a
five-year high growth period and a 10-year maturity period,
followed by a declining period.
• Base case value – 60% weighting (unchanged): Down 9%
from Rs3,315 to Rs3,025 per share.
• Bear case value – 20% weighting (unchanged): Down 9%
from Rs1,815 to Rs1,650 per share.
• Bull case value – 20% weighting (unchanged): Down 10%
from Rs4,000 to Rs3,600 per share.
Life insurance business: For this we use an appraised value
method. We compute the embedded value at Rs32.5bn. To
this, we add value of new business to get a base-case value for
the life business of Rs135 per share.
Risks to Our Price Target
Key downside risks to our price target include slower-thanexpected
loan growth, sharp compression in NIMs, and
significant deterioration in asset quality (restructured loans
slippages).
Upside risks include: fee income being stronger than
expectations and credit costs being lower than expectations
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