State Bank of India Size doesn’t matter : Macquarie Research

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State Bank of India
Size doesn’t matter
Event
 Maintain Underperform with TP of Rs1,700: We remain bearish on SBI
mainly due to asset quality issues which are unlikely to abate in the near
future. Maintain Underperform.

Impact
 Asset quality – the biggest worry: The key worry continues to be asset
quality and slippages have been stubbornly high at 4% of advances for quite
some time. Management recently clarified at our conference that sectors like
aviation, metals, sugar, those companies dependent on state utilities like cable,
and transformer companies have contributed to the NPLs. The key worry is the
large level of NPLs seen in agri, SME and the mid-corporate sector where
Gross NPL ratios are at 9.5%, 7.9% and 5.5%, respectively.
 Agri sector – recoveries hold the key and they have been unsatisfactory:
Agri NPLs have risen rapidly from less than 3% in FY09 to 9.5% as of Dec-
2011. The moral hazard issue due to the debt waiver has resulted in farmers
defaulting on agri loans. SBI also doesn’t have a choice but to lend to this
segment in order to meet the priority sector obligations and government
diktats. The issue has also been the level of recoveries in the agri segment,
which continues to be quite disappointing.
 Expect stressed assets to net-worth to increase to 76% by FY13E: We
expect stressed assets to net-worth to increase to 76% by FY13E from the
54% seen in FY11. We expect restructuring to pick up in 4QFY12 and FY13.
However the level of restructured assets will be lower for SBI compared to its
peers owing to its lower exposures to various stressed sectors like power,
aviation etc.
 Margins have peaked and opex to increase: SBI’s 3Q12 NIMs at 4% plus
are close to all-time highs, and we think NIMs have peaked and could come
down as rate cuts begin given that nearly 70-75% of loans are at floating rates.
Also we expect pressure on opex due to impending wage negotiations due
from Nov-2012 which could result in higher salary costs and employee benefits
like pensions. Cost-income ratio should inch up by 200bps by FY14E.
Earnings and target price revision
 We increase our FY13E and FY14E earnings by 8% and 1% on account of an
increase in margins, which have been maintained at high levels. TP remains
unchanged at Rs1,700.
Price catalyst
 12-month price target: Rs1,700.00 based on a Sum of Parts methodology.
 Catalyst: High slippages and increase in restructured assets
Action and recommendation
 Frequent equity dilution imminent, Maintain Underperform: The expected
capital infusion of Rs79bn from the government is insufficient and we expect
more equity dilution over the course of the next five years driven mainly by
Basel-III requirements.


Valuations
We value SBI on a sum-of-parts basis, and we value the core banking business using a two-stage
Gordon Growth Model. The life insurance business is valued using the appraisal value method,
which is embedded value plus new business value.
Fig 6 SBI – sum-of-parts methodology
Cost of equity 13.0%
RoE 14.8%
g (initial growth) 12%
n(initial growth period) 10
Steady growth 4%
Theoretical P/BV – using two stage Gordon growth model 1.3x
FY13E adjusted book value (INR) – Adjusted for Net NPLs 1,413
Assumed restructuring hit at 15% to gross book value 253
Book value used in calculation of fair value 1,160
Fair value based on BV (INR) 1,520
Valuation of life insurance (INR) 163
Target Price (Rounded off) 1,700
Source: Macquarie Research, March 2012