PNB- Downgrade to Neutral: Not yet out of the woods: HSBC

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Punjab National Bank (PNB)
Downgrade to Neutral: Not yet out of the woods
􀀗 2Q profit came in 3% below estimates despite positive margin
surprise; opex, asset quality are near-term concerns
􀀗 2H this year likely to see slower growth, lower margins,
sustained slippages, and firm cost income ratios
􀀗 Downgrade to Neutral, raise target price to INR1,375 (from
INR1,226), implying potential return of 7%; remove V-flag




2Q FY11 results were a mixed bag, with margins firming up nicely to 4% on the back of
loan yields ticking up with flat deposit costs; however, the stock closed 2% lower on the
back of negative surprise on the opex and NPL slippages.

Key themes were a pick-up in loan growth to 28%, with margins ticking up 12bp q-o-q,
offset by 53% higher employee expenses and higher NPL provisions. Loan growth was
driven by SME and retail; CASA mix stayed firm at 41%, resulting in the margin uptick.

However, slippages – although sequentially lower – remain at an elevated level of 1.7%, with
the risk of further additions from the relatively large restructured book in the near term.
Earnings outlook. Based on the above trends, we increase our provisioning estimates,
leading to 14% and 13% earnings cuts to our FY11 and FY12 estimates. However, despite
these cuts, we continue to estimate a robust earnings CAGR of 27% after milder 15% growth
in the current year; 2H this year is likely to be slow given decelerating loan growth y-o-y,
some retreat in margins, and elevated opex and provisioning levels.

Valuation and risks. Our revised 12-month target price of INR1,375 implies a 7% potential
return and, accordingly, we downgrade the stock to Neutral. We continue to value PNB
using a weighted average combination of PE, PB and EPM methodologies. For PE and PB, we
set our target multiples after examining historical trading patterns and, hence, use 12- and
24-month forward EPS and BV; we believe historical trading ranges alone are no longer
applicable, as the valuation gap between PSU and private-sector banks has narrowed due
to fundamental performance and as liquidity continues to flow into India’s equity markets.
We derive target PE and PB multiples of 6.8x and 1.4x respectively.

Key upside risks to our rating and estimates: (1) Much improved pricing power and
hence margins; (2) lower-than-estimated pension liability. Key downside risk: Any
significant downturn in asset quality.

Potential stock catalysts: Having outperformed many of its peers YTD, PNB is likely to
remain range-bound, especially in the near term, given the twin credit and operating cost
pressures. Slowing 2H top-line trends are also likely to supplement this view.