Canara Bank (CNBK.BO) Low Valuations But High Vulnerability to Macro Deterioration Citi,

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Canara Bank (CNBK.BO)
Low Valuations But High Vulnerability to Macro Deterioration
 Reducing Target Price to Rs375, maintain Sell — We are revising our EVA
based target price for Canara Bank to Rs375, maintaining our Sell/Medium Risk
rating. While the stock has underperformed sharply in recent months (-15% vs
Sensex and -12% vs Bankex in 6 months) and valuations are relatively low;
Canara remains among the most exposed to macro pressures (interest rates,
growth and asset quality) and therefore the impact on earnings will likely be
higher if the macro deteriorates further.
 Cutting Earnings By 13/8% over FY12/13E — We are reducing our earnings
estimates over FY12/13E by 13/8% to incorporate softer growth prospects,
weaker margins and higher credit costs.
 Concerns on Quality, Funding and Margins — Canara Bank has structurally
been more vulnerable to a difficult macro, relative to peers, on the back of: a)
Aggressive loan growth coupled with higher exposures to infrastructure (16% of
which 9% is in Power); b) Weaker deposit franchise (CASA Ratio decreased to a
modest 25%); and c) Sharp deterioration in asset quality (NPLs jumped 17% qoq
in 1Q12) with relatively lower coverage levels (70%). Additionally, margin
headwinds are also visible and add to the concerns. This should keep valuations
at a meaningful discount to better government banking franchises.

 Quant View: Contrarian — As per our quantitative methodology, Canara Bank
lies in the Contrarian quadrant of our Value-Momentum map with relatively weak
momentum despite its relatively attractive valuations, relative to peers.


Canara Bank currently lies in the Contrarian quadrant of our Value-Momentum map
with relatively weak momentum but strong value scores. The stock has moved from
the Attractive quadrant to the Contrarian quadrant in the past 3 months indicating a
fall in momentum scores, even though the stock has maintained an attractive
valuation score. Compared to its peers in the Banks sector, Canara Bank fares
better on the valuation metric but worse on the momentum metric. Similarly,
compared to its peers in its home market of India, Canara Bank fares better on the
valuation metric but worse on the momentum metric.
From a macro perspective, Canara Bank is likely to benefit from falling commodity
(ex-oil) prices, falling EM yields, and a weaker US Dollar.


Canara Bank
Company description
Canara Bank (Canbank) was incorporated in 1910 and nationalized in the first
round in 1969. The bank is headquartered in Bangalore, Karnataka. The
government holds 68% of the bank's equity. Canara Bank is among the top-five
banks in the country, with nearly 6% share in deposits and advances of the banking
system. The bank has a large nationwide network of over 3,277 branches and 2509
ATMs.
Investment strategy
We rate Canbank Sell/Medium Risk (3M). It is one of India's larger government
banks that have recorded strong growth over the past five years, with increasing
ROE (over 20% in FY11). It has also maintained rapid loan growth, which has
traditionally been above the industry average. It is one of India's largest banks and,
we believe, is among the best positioned to participate in relatively large capexrelated
funding. However, Canbank has a mixed record of asset quality, higher than
industry exposure to the vulnerable infrastructure and power segments; and while
its NPA levels have improved, its coverage levels remain the lowest among peers,
and its rapid growth does increase concerns. It has been inconsistent with its
margins (now well below peers at 2.4%), its modest funding mix (25% CASA) and
high reliance on bulk deposits suggest continuing pain in the current liquidity
environment. We believe Canara is an aggressive and slightly higher risk relative to
peers and, while valuations have corrected, near-term operational pain is likely to
cap any upsides.
Valuation
Our target price of Rs375 is based on CIRA's EVA model, which in our view
captures the long-term value of the business and which is a standard valuation
measure for the CIRA India banking universe. Our target price is premised on: a)
risk free rate of 8.0%; b) lower than industry long term loan loss provisions of 90bps,
c) loan spreads of 190bps, lower than industry average levels, and d) long term fee
income growth of 8%. We benchmark our target price on a 0.7x 1Yr Fwd P/BV
(Sep'12), which is at a significant discount to fair-value multiples for higher-quality
government banks, on account of Canara's relatively modest funding mix and an
often aggressive approach to growth and trading. Our implied P/BV-based fair value
is Rs387.
Risks
We rate Canara Bank Medium Risk, even as our quantitative risk-rating system,
which tracks 260-day historical share price volatility suggests Low Risk. We believe
Canara’s moderate funding mix and relative higher earnings sensitivity to the
interest rate environment suggests Medium Risk. Key upside risks to our target
price include: 1) Improvements in the asset quality environment; 2) Relatively easier
liquidity and interest rate environment, which should protect NIMs and lead to bond
portfolio gains; 3) Improvements in the low cost deposit mix.