Oriental Bank of Commerce - Risk reward favorable; upgrade to Buy; company update; upgrade to Buy; : Edelweiss PDF link

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Oriental Bank of Commerce (OBC IN, INR 255, upgrade to Buy)

We had downgraded our recommendation on Oriental Bank of Commerce (OBC) to ‘REDUCE’ in August 2011 (refer our note ‘Banking - Macro challenges getting serious’ dated August 29, ‘11) fearing earnings downgrade due to its vulnerability to asset quality risk (chunky power exposure to SEBs) and margin pressure (short term/wholesale dependant borrowing profile). Since then, consensus has revised earnings down 25% and the stock has also underperformed Bankex by 26%. At 0.7x FY13E adjusted book, we believe the risk-reward has turned favorable—given our view that wholesale rates will settle at lower levels in FY13 and slippages are close to peaking out (higher credit cost already built into consensus estimate). Hence, we upgrade our recommendation to ‘BUY’ with a TP of INR 337 (0.9x FY13 ABV).

Key beneficiary of reversal in short term rates: High correlation

OBC’s margin behavior is highly correlated to movement in short-term wholesale rates due to its liability profile: (i) relatively higher proportion of deposits maturing less than one year at ~70% and 25-30% of its deposits are wholesale in nature. With short term wholesale rates set to decline over FY13, OBC will be positively impacted.

Asset quality risk: Remain but closing to peaking out

Slippages and restructured assets for OBC have remained elevated (largely contributed by system based NPL recognition) and we do not expect a material improvement in the coming quarters. Even if we consider 20% of restructured assets to slip into NPLs and consequently adjusting book value, the stock still attractively trades at 0.75x.

Outlook and valuations: Risk-reward favorable; upgrade to ‘BUY’

Led by improving margin profile, we revise our earnings by 5%/10% respectively for FY13/14 and expect the bank to deliver 30% CAGR in earnings over FY12-14 with ROE profile improving from ~11.5% to 16% in FY14E. Despite not expecting a major swing in asset quality performance, we believe the valuation at 0.7x FY13E adj. book turn risk-reward metrics in the favorable zone. Hence, we upgrade to BUY. 

Oriental Bank of Commerce - Risk reward favorable; upgrade to Buy; company update; upgrade to Buy

Regards,