Canara Bank Asset quality to remain an overhang : Macquarie Research

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Canara Bank
Asset quality to remain an overhang
Event
 Maintain Underperform: We expect Canara’s ROE to come down from 23%
seen in FY11 to 15-16% by FY14E driven by lower ROA and leverage.
Maintain Underperform with a revised TP of Rs385
Impact
 Asset quality can worsen further: Amongst our coverage, Canara has the
largest exposure to the private power companies and SEBs; close to 12-13%
of its loans are exposed to the power sector. We expect stressed assets as a
% of net worth to double from 50% in FY11 to 100% in FY13E, driven by large
restructurings in the power sector.
 Falling loans to deposits to exert pressure on margins: In 3Q12,
advances have grown only 15.5% YOY and deposit growth has been healthy
at 20%. We expect the trend to continue going forward as deposits tend to be
stickier than advances growth. We expect loans to grow at ~250bps higher
than deposits over FY12-14E. This gap between deposit growth and credit
growth is likely to exert pressure on margins, as investing term deposits in
government securities is currently yielding a negative carry.
 Poorest deposit franchise: Canara Bank’s CASA at sub-25% levels (fallen
steeply by ~400bps in the last year) is the lowest amongst large banks, and
the bank traditionally has relied on a large quantum of bulk deposits to fund
growth. We believe that bulk deposits rates are unlikely to soften soon, putting
further pressure on NIMs.
 Grossly under-provisioned: The reported NPL coverage ratio in 3Q12 at
18% is perhaps the lowest in the sector. We are extremely concerned about
the bank’s current state of under-provisioning. If we include restructured
advances which stand at Rs96bn (4.4% of overall book), under-provisioning
gets aggravated further. Due to this, we are factoring credit costs to increase
by 60% YOY in FY13
 Management change due in Sept-12: Management changes in PSU banks
have caused a lot of uncertainty, as reflected by past experience, and the
current Chairman is due for retirement in Sept-2012.
Earnings and target price revision
 We reduce our FY13E and FY14E EPS by 12% and 11%, respectively, on
account of higher credit costs and slower growth. We increase our TP by 4%
to Rs385 on account of reduction in the cost of equity.
Price catalyst
 12-month price target: Rs385.00 based on a Gordon Growth methodology.
 Catalyst: Increased slippages and restructuring, margin pressures
Action and recommendation
 Maintain Underperform with revised TP of Rs385
Valuations and TP
We value CBK 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 CBK – sum-of-parts methodology
Cost of equity 12.8%
RoE 12.9%
g (initial growth) 10%
n(initial growth period) 5
Steady growth 4%
Theoretical P/BV – using two stage Gordon growth model 1.07x
FY13E adjusted book value (INR) – Adjusted for Net NPLs 438
Assumed restructuring hit at 20% to gross book value 81
Book value used in calculation of fair value 357
Target Price (Rounded off) 385
Source: Macquarie Research, March 2012