Bank of Baroda Comforts waning, concerns prop up : Macquarie Research

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Bank of Baroda
Comforts waning, concerns prop up
Event
 Downgrade to Underperform. Historically BOB has traded at a premium to its
peers owing to its sound asset quality and superior management. However with
those seen waning with increasing slippages and management change, we
expect the stock will de-rate. Downgrade to Underperform with a revised TP of
Rs705.
Impact
 Asset quality concerns to accelerate: Slippages and credit cost at 1% and
0.5% in FY11 are the lowest reported by BOB in its history. Delinquencies have
started increasing with 2Q12 and 3Q12 reporting slippage ratio of 1.5% and
2.2% respectively. Restructured assets have also increased 50% in 9M FY12
and currently stand at 3.8% of loans. BOB, although last in the league of PSU
banks to see asset quality problems would incur high credit cost over next
couple of years. We expect credit cost to shoot up by 24.2% over FY12-14E.
 Business growth to moderate considerably. BOB’s loan growth has
remained healthy till FY11 (CAGR of 29% over FY08-11). However, in 9MFY12
growth was aided by INR depreciation fuelling overseas advances growth.
Domestic credit growth was muted at 6% YTD. We expect loans growth to
come-off sharply from the high of FY11 and likely to remain at 17% over FY12-
14. This would put pressure on leverage and drag ROE.
 Margins to remain under pressure: We expect NIM to slide from 3.1% seen
in FY11 by ~20bps over FY12-14 owing to lagged effect of repricing of deposits
and slowing CASA traction (declined from 37% since two year ago to 34% in
3Q12).
 Management change makes us more cautious: BOB has done extremely
well under the current CMD Mr. Mallya (since FY09) in terms of franchise
creation, business growth with one of the best asset quality among peers. This
has led BOB to trade at premium to basket of comparable PSU banks. We
would remain cautious of management change as they tend to be quite
disruptive in PSU banks. Mr. Mallya retires in Nov-2012.
Earnings and target price revision
 We marginally adjust our FY13E EPS and reduce FY14E EPS by 6% on
account of slower growth and higher credit costs. We reduce our TP by 5% to
Rs705 on account of lower ROE and lower adjusted book value.
Price catalyst
 12-month price target: Rs705.00 based on a Gordon Growth methodology.
 Catalyst: Increase in NPLs, restructured assets and loan growth
Action and recommendation
 Downgrade to underperform: We expect BOB’s ROE to come down from
24% seen in FY11 to 17% by FY14E driven by lower ROA and leverage.
Downgrade to Underperform with a revised TP of Rs705.
Valuations and TP
We value BOB on a two stage Gordon growth model using:
P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate
for the first n (high-growth period) years, p=payout ratio in the first n years, gn=perpetual growth rate,
pn=perpetual payout ratio.
Fig 1 BOB – sum-of-parts methodology
Cost of equity 14%
RoE 14.8%
g (initial growth) 12%
n(initial growth period) 5
Steady growth 4%
Theoretical P/BV – using two stage Gordon growth model 1.24x
FY13E adjusted book value (INR) – Adjusted for Net NPLs 678
Assumed restructuring hit at 20% to gross book value 106
Book value used in calculation of fair value 573
Target Price (Rounded off) 705
Source: Macquarie Research, March 2012