Union Bank - Earnings impacted by one-offs. :: Kotak Sec

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Union Bank (UNBK)
Banks/Financial Institutions
Earnings impacted by one-offs. Union Bank 2QFY11 earnings declined sharply
(40% yoy) due to higher staff costs (up 94% yoy) and loan loss provisions (up 6X yoy).
However, NIM (adjusted) improved by 32 bps qoq. We revise estimates downwards for
FY2011E (13%) and FY2012E (7%), as we increase employees expenses for higher
pension costs. Despite lower earnings, we still see the bank deliver RoE of 22% in
FY2012E. Valuations at 1.5XFY12E remain reasonable. We will be buyers in case of
sharp decline in price. Retain BUY with TP of `450.


Earnings impacted by few one-offs which is unlikely to repeat; maintain BUY
While 40% decline in net profits does disappoint, we maintain our BUY recommendation on the
stock as we don’t expect to see a repeat of current quarter performance. The bank disappointed
on two counts –
Higher slippages resulting in higher provisions: Slippages increased sharply to `11.3 bn, out
of which, agriculture debt relief contributed about `4.2 bn and couple of specific corporate
accounts contributed another `3 bn, which we believe are one-off in nature. While the annualized
delinquency for 2Q is 3.6%, adjusting for one-offs the slippages were 1.3%. Thus, slippages are
likely to decline sharply in future quarters resulting in lower loan loss provisions. The management
expects gross NPLs to fall below 2.3% by March 2011E from 2.8% currently.
Higher pension and gratuity cost: This was a bigger disappointment, as the management
highlighted that the required pension shortfall is `24 bn, compared to an earlier guided/expected
figure of `12 bn. This resulted in pension provision of `1.2 bn during the quarter and will inflate
employee expenses by `2.4 bn for FY2011E, compared to our earlier estimates. In addition, the
bank also accounted for 1Q gratuity expenses of `1.3 bn during 2Q, resulting in higher employee
expenses. The full year gratuity costs of Rs2.5 bn will be limited for FY2011E and not repeat
thereafter, pension expenses of Rs4.8 bn per annum will repeat every year for next five years.
On the positive side, margins remained strong. Management still targets a loan growth of 25%,
RoAs of 1.17% and RoEs of 22%+ during FY2011E. We broadly believe that Union Bank has the
underlying strength to deliver these goals, as the macro environment is favorable for asset growth
and lower NPL risk.
We have taken conservative assumptions factoring the revised retirement costs (56% yoy growth
in FY2011E staff expenses). We reduce our earnings by 13% in FY2011E and 7% in FY2012E,
factoring in higher pension provisions. However, valuations at 1.5XFY2012E PBR for RoEs of about
22%, still remain attractive. On PER basis, the stock trades at 7x FY2012E. We remain positive and
maintain our TP of `450.