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Oriental Bank of Commerce
F3Q11: Weak Trends; Maintain OW on Valuations
What's Changed
Price Target Rs600.00 to Rs470.00
EPS F11e, 12e, 13e -7%, -23%, -16%
OBC reported profits of Rs4.1 bn for QE-Dec-10.
Profits were up 3% QoQ / 41% YoY; our estimate was
Rs3.5 bn. The key reasons for the beat were lower than
expected NPL provisions and effective tax rate. This
was offset by weaker NII progression.
Key highlights from the results include:
a) Volume growth was muted. Loans grew by 6% QoQ
/ 16% YoY. Deposits grew by 3% QoQ / 17% YoY.
CASA moved lower 20 bps QoQ to 25.2%.
b) NIM fell by 20 bps QoQ to 3.1% (up 10 bps YoY). NII
grew by 5% QoQ / 18% YoY.
c) OBC indicated that its second pension option
related liability is going to be Rs11.1 bn (earlier
guidance was Rs6 bn). However, excess provisions
of Rs4.1 bn from the wage hike will provide a buffer.
d) New NPL formation went up materially from Rs3.2
bn (1.4% of loans, ann.) in F2Q to Rs4.8 bn (2.2%)
in F3Q. However, credit costs dropped (from 100
bps in F2Q to 80 bps in F3Q) – resulting in coverage
ratio falling QoQ (down 4% points to 77%)
Maintain OW but reduce PT/estimates: Given the
weak liability franchise, OBC is likely to see margins
compress during the coming year. We were projecting
NIM compression – but now build in a sharper fall to
2.5% by end-F12. However, valuations are attractive at
5.7x F12e P/E and 0.8x BV and provide margin of safety
– hence we maintain our OW. We are reducing our price
target from Rs600 to Rs480. We now apply a higher
probability to our bear case (20%) to factor in increased
uncertainty about economic growth following recent
developments with regard to inflation.
Target Price Discussion
We arrive at our price target of Rs480 using a probability
weighted three-phase residual income model – a five-year high
growth period, a 10-year maturity period, followed by a
declining period.
We have reduced our earnings estimates by 7%, 23% and
16% in F2011, F2012 and F2013, respectively: Three factors
drive the decrease. a) We now build in a sharper than expected
margin compression (driven by rise in short rates filtering
through). b) Management increased its estimate of second
pension related liability to Rs11.1 bn vs. initial guidance of Rs6
bn. c) We have also built in lower loan growth of 16% in
F2012/13 (vs. 22% initially)
Previously, we valued the stock only on the base case
scenario. However, we are shifting to a probability-based
valuation methodology to reflect the following:
a) 20% weight to bear case scenario: We factor in the
increased economic growth uncertainty following recent
developments with regard to inflation. There is a risk that if
inflation were to be sustained at higher level for longer,
there may be a disruptive rise in interest rates – hence
leading to asset quality issues. We believe that until
inflation expectations are brought under control, the
market is likely to continue to assign a reasonable
probability to this outcome.
b) 20% weight to bull case scenario: We factor in the
potential for stronger than expected economic growth and
better than expected performance of underlying
businesses at OBC.
We have reduced our bull case value by 18%, to Rs575
per share and our base case value by 15%, to Rs510 per
share; our bear case value decreases by 17% to Rs250
per share.
c) We assign the residual 60% weight to the base case
scenario: This is premised on our expectation that
economic growth will remain robust in the coming year.
This will help credit costs to decline. However, in this
scenario we build in margin compression for OBC from
current levels as the impact of rising rates will continue to
filter through.
We use a cost of equity of 14.1% (up from 13.5%), assuming a
beta of 1.0, a risk-free rate of 8.1% (current Indian 10-year
government bond yield), and a market risk premium of 6%.
Risks to Our Price Target
Key downside risks to our price target include
slower-than-expected loan growth, sharp compression in NIMs
and significant deterioration in asset quality (restructured loans
slippages).
Upside catalysts include: fee income being stronger than
expectations and credit costs being lower than expectations
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� �
Oriental Bank of Commerce
F3Q11: Weak Trends; Maintain OW on Valuations
What's Changed
Price Target Rs600.00 to Rs470.00
EPS F11e, 12e, 13e -7%, -23%, -16%
OBC reported profits of Rs4.1 bn for QE-Dec-10.
Profits were up 3% QoQ / 41% YoY; our estimate was
Rs3.5 bn. The key reasons for the beat were lower than
expected NPL provisions and effective tax rate. This
was offset by weaker NII progression.
Key highlights from the results include:
a) Volume growth was muted. Loans grew by 6% QoQ
/ 16% YoY. Deposits grew by 3% QoQ / 17% YoY.
CASA moved lower 20 bps QoQ to 25.2%.
b) NIM fell by 20 bps QoQ to 3.1% (up 10 bps YoY). NII
grew by 5% QoQ / 18% YoY.
c) OBC indicated that its second pension option
related liability is going to be Rs11.1 bn (earlier
guidance was Rs6 bn). However, excess provisions
of Rs4.1 bn from the wage hike will provide a buffer.
d) New NPL formation went up materially from Rs3.2
bn (1.4% of loans, ann.) in F2Q to Rs4.8 bn (2.2%)
in F3Q. However, credit costs dropped (from 100
bps in F2Q to 80 bps in F3Q) – resulting in coverage
ratio falling QoQ (down 4% points to 77%)
Maintain OW but reduce PT/estimates: Given the
weak liability franchise, OBC is likely to see margins
compress during the coming year. We were projecting
NIM compression – but now build in a sharper fall to
2.5% by end-F12. However, valuations are attractive at
5.7x F12e P/E and 0.8x BV and provide margin of safety
– hence we maintain our OW. We are reducing our price
target from Rs600 to Rs480. We now apply a higher
probability to our bear case (20%) to factor in increased
uncertainty about economic growth following recent
developments with regard to inflation.
Target Price Discussion
We arrive at our price target of Rs480 using a probability
weighted three-phase residual income model – a five-year high
growth period, a 10-year maturity period, followed by a
declining period.
We have reduced our earnings estimates by 7%, 23% and
16% in F2011, F2012 and F2013, respectively: Three factors
drive the decrease. a) We now build in a sharper than expected
margin compression (driven by rise in short rates filtering
through). b) Management increased its estimate of second
pension related liability to Rs11.1 bn vs. initial guidance of Rs6
bn. c) We have also built in lower loan growth of 16% in
F2012/13 (vs. 22% initially)
Previously, we valued the stock only on the base case
scenario. However, we are shifting to a probability-based
valuation methodology to reflect the following:
a) 20% weight to bear case scenario: We factor in the
increased economic growth uncertainty following recent
developments with regard to inflation. There is a risk that if
inflation were to be sustained at higher level for longer,
there may be a disruptive rise in interest rates – hence
leading to asset quality issues. We believe that until
inflation expectations are brought under control, the
market is likely to continue to assign a reasonable
probability to this outcome.
b) 20% weight to bull case scenario: We factor in the
potential for stronger than expected economic growth and
better than expected performance of underlying
businesses at OBC.
We have reduced our bull case value by 18%, to Rs575
per share and our base case value by 15%, to Rs510 per
share; our bear case value decreases by 17% to Rs250
per share.
c) We assign the residual 60% weight to the base case
scenario: This is premised on our expectation that
economic growth will remain robust in the coming year.
This will help credit costs to decline. However, in this
scenario we build in margin compression for OBC from
current levels as the impact of rising rates will continue to
filter through.
We use a cost of equity of 14.1% (up from 13.5%), assuming a
beta of 1.0, a risk-free rate of 8.1% (current Indian 10-year
government bond yield), and a market risk premium of 6%.
Risks to Our Price Target
Key downside risks to our price target include
slower-than-expected loan growth, sharp compression in NIMs
and significant deterioration in asset quality (restructured loans
slippages).
Upside catalysts include: fee income being stronger than
expectations and credit costs being lower than expectations
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