Bank of Baroda- Still the best among PSUs, but risks emerge ::Macquarie Research,

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Bank of Baroda
Still the best among PSUs, but risks
emerge
Event
 Downgrade to Neutral as risks emerge: We are wary of asset quality issues
at Bank of Baroda (BOB) and downgrade the stock to Neutral with TP of
Rs800. We are cutting our earnings and TP sharply.
Impact
 Asset quality expected to deteriorate: BOB’s credit costs, at 40bp in
FY12E, are close to historical lows, and we expect them to increase by 30bp
over the next two years, driven by an increase in restructured assets and
higher slippages. BOB’s slippage ratio, at 1% of advances, is the lowest
observed in its history. The bank does have a large exposure to the
beleaguered airline, Air India (unlisted), and we do expect stressed assets as
a proportion of net worth to increase, from 36% in FY11 to 78% in FY13E.
This is still much better than the 100% stressed assets proportion that we see
on average for its peers.
 Management change in November 2012: The current CMD, Mr. Mallya, is
expected to superannuate/retire in November 2012. Management changes
have caused a lot of uncertainty at PSU banks, as reflected by past
experiences. Mr. Mallya has been instrumental in turning around BOB, and
his exit, in our view, is bound to have some negative impact.
 Return ratios to remain higher than peers: BOB’s return ratios, with ROA
at 1.3% and ROE at 24% for FY11, are expected to come down and
normalise at around 1.1% and 18–19%, respectively, still higher than its
peers’. Consequently the stock could continue to trade at a premium valuation
to its peers.
 No major worries on international business: The international business,
which comprises 20% of the overall business, is predominantly depositfunded;
it is largely involved in trade finance, and exposure is mainly to Indian
corporates. The bank has a large exposure to the Middle East; however,
some of the problematic exposures, like Dubai World (unlisted), have already
been restructured.
Earnings and target price revision
 We cut our earnings by 13% for FY13E and 17% for FY14E, mainly on
account of higher credit costs. We cut our TP by 27% to Rs800, mainly
because we reduced our target multiple from 1.6x to 1.2x. The reduction is on
account of lower ROE and lower earnings growth.
Price catalyst
 12-month price target: Rs800.00 based on a Gordon Growth methodology.
 Catalyst: Increase in NPLs/slippages and quantum of restructured assets.
Action and recommendation
 Neutral with TP of Rs800, favourite amongst PSUs: For investors wanting
to gain exposure to a PSU bank just because it is cheap, we recommend
Bank of Baroda, considering its track record and fundamentals.

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