Canara Bank Margin surprise: 2Q11 (Sept 2010): Macquarie Research

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Canara Bank
Margin surprise
Event
 Canara Bank reported 2Q11 net profit of Rs10.1bn, up 11%YoY and 17%
above our estimate. The surprise was driven by better-than-expected margins
and lower provisions. We raise our earnings estimates and TP (to Rs520 from
Rs405), mainly driven by the higher margins and lower provisioning. However,
maintain our Underperform rating given the earnings headwinds.
Impact
 Margin surprised but may not be sustainable. NIMs surprised on the
upside. 2H11 margins were 3.16% compared to 3.1% in 1Q. This was mainly
due to higher loan and investment yields. We expect deposit rate hikes to
catch up with a lag. Given the poor CASA franchise, the higher funding costs
will likely affect Canara’s NIMs more than its peers’. Accordingly, the margins
should be unsustainable.
 Loan growth sees a sharp slowdown. Loan growth slowed from 23% in
1Q11 to 20% in 2Q11. The loan book was practically flat QoQ. While home
loans showed good traction, the chief drag was the contracting corporate loan
book. Last quarter, much of the lending that occurred was telecom-related,
and the bank clearly struggled to expand its corporate book this quarter.
 NPLs remain underprovided. While the NPL coverage, including technical
write-offs, is 77%, the provision on the existing block of NPLs is very poor at
29%, down from 32% in 1Q11. This compares with ~60% coverage ratio for
Canara’s peers. NPLs were up 3%QoQ. While we wait for more clarity from
the management on the asset-quality situation at the bank, we believe that
there is a risk of increased delinquencies from both the restructured and
nonrestructured book of the bank.
 Fee income growth was sluggish at 12% YoY. This, we believe, is largely
related to the slowdown in lending and could continue.
Earnings and target price revision
 We have increased our FY11, FY12 and FY13 earnings estimates by 29%,
11% and 7%, respectively. This is mainly driven by higher margins and lower
provisioning. Our TP increases to Rs520, reflecting a higher P/BV multiple
and higher BVPS.
Price catalyst
 12-month price target: Rs520.00 based on a Gordon Growth methodology.
 Catalyst: Declining margins and higher NPLs in 2H11.
Action and recommendation
 The stock currently trades at 1.7x adjusted FY12E BVPS. Given the earnings
headwinds, we believe that the current valuations may be unsustainable. We
maintain our Underperform rating, with a higher TP that values the stock at
1.3x FY12E adjusted BVPS.