Punjab National Bank - Gone awry! : Macquarie Research

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Punjab National Bank
Gone awry!
Event
 Structural de-rating in the making: We expect PNB’s ROE to come down
from the 23% seen in FY11 to 17% by FY14E driven by lower ROA and
leverage. Maintain Underperform with a revised TP of Rs790.

Impact
 Asset quality – the pain point, expect stressed assets to net-worth to
shoot up: Quantum of slippages as well as restructuring is expected to
remain high. We believe PNB, in its quest for high margins, has gone into high
risk lending and that has resulted in asset quality being consistently bad
quarter after quarter. We expect stressed assets as a proportion of net-worth
to increase to 92% by the end of FY13E from a level of 50% seen two years
ago. More large restructurings like Air India and Rajasthan SEBs are due over
the course of the next few quarters.
 Book value grossly overstated due to large restructuring: We believe
looking at FY13E book value and arguing that valuations look cheap is
meaningless in the context of a large restructured book which constitutes 6%
of overall loans. Many restructured exposures like the TNSEB exposure don’t
even carry any meaningful provisions as they have been done on a zero NPV
loss basis.
 Steady deterioration of franchise worries us: The CASA ratio has steadily
declined over the past ten quarters, going down from a whopping 470bps
since June-2010 to 36.2% in 3Q12. The bank has been utilising bulk deposits
to fund growth which leaves it vulnerable to sudden tightness, in our view.
Despite such a sharp deterioration of quality of its franchise, PNB’s NIMs
have hardly declined and have been maintained at around 3.9%.
 Expect frequent equity dilution: The bank has already diluted its equity
base by 9% in FY12E and we expect equity dilution again to happen in the
next 12 months as the bank gears up for Basel-III capital requirements.
Earnings and target price revision
 We reduce our FY13E and FY14E EPS by 7% and 14%, respectively, on
account of higher credit costs and equity dilution. We reduce our TP by 10%
to Rs790 on account of lower ROE and lower adjusted book value.
Price catalyst
 12-month price target: Rs790.00 based on a Gordon Growth Model
methodology.
 Catalyst: Increase in slippages and restructured assets quantum.
Action and recommendation
 Reiterate Underperform: Historically PNB has traded at a premium to its
peers owing to its superior returns. However with those superior return ratios
unlikely to be seen going ahead, the stock is expected to de-rate further.
Reiterate Underperform with a new TP of Rs790.


Valuations and TP
We value PNB 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 3 PNB – sum-of-parts methodology
Cost of equity 13.5%
RoE 14.8%
g (initial growth) 11%
n(initial growth period) 5
Steady growth 4%
Theoretical P/BV – using two stage Gordon growth model 1.22x
FY13E adjusted book value (INR) – Adjusted for Net NPLs (Rs/sh) 826
Assumed restructuring hit at 20% to gross book value (Rs/sh) 179
Book value used in calculation of fair value (Rs/sh) 647
Target Price (Rounded off) (Rs/sh) 790
Source: Company data, Macquarie Research, March 2012