Equal chance

IPO REVIEW

Central Bank of India faces both the opportunities and challenges of any typical government owned bank but the issue price is reasonable.

Banking stocks have been investors' favourite for quite some time so much so that the BSE Bankex touched its all time high last week. Since the beginning of this calendar, the Bankex has gained about 18 per cent compared to the Sensex gain of around 11 per cent. Such optimism is because of the popular belief that interest rates may not rise further meaning the worst for banks may be over.

Top banks like ICICI Bank and HDFC Bank have already taken advantage of the good times by raising money through follow-on public offers and ADRs respectively. The latest to join the bandwagon is the 96-year old, 100 per cent government owned Central Bank of India.

Central Bank plans to offer 8 crore shares (while reserving 0.4 crore shares for employees) in the price band of Rs 85-102 raising Rs 680-816 crore in order to enhance its capital required to sustain growth and to adhere to the Basel II norms.

Post-issue, the government's holding will come down to 80.2 per cent and its capital adequacy ratio (CAR) will rise closer to 12 per cent from the current 10.4 per cent.

Boasting of a business size of nearly a lakh crore, Central Bank seems reasonably priced at 1.1-1.3 times its book value for last year. Considering the estimated book value of Rs 90 for the current year, the stock commands a P/BV of 0.9-1.1 times.

Close peer Union Bank of India with almost similar size trades at 1.6 times its book value for last year. One key difference however is that Central Bank has a lower return on equity of 15 per cent compared to the latter at 19 per cent.

Says Ajit Dange, analyst, Pioneer Intermediaries, "The IPO have been decently valued providing potential for listing gains." Rating agency CARE has done the IPO grading and indicated 'above average fundamentals' for the issue. For the longer term, the stock provides potential for price appreciation as the bank gears up to keep pace with India's growth story. 
 

VALUED RIGHTLY
FY07	Business  (Rs cr)	% chg	NIM (%)	Net profit (Rs cr)	% chg	P/BV	RONW	ROAA
CBI*	1,33,748	27.80	3.16	498.00	93.80	1.1-1.3	15.10	0.60
Canara Bank	2,40,900	22.80	3.15	1420.80	5.80	1.45	18.80	1.00
Bank of India	2,06,700	28.70	3.70	1123.20	60.00	2.26	21.30	0.90
Bank of Baroda	2,08,736	35.90	3.10	1026.50	24.00	1.29	12.50	0.80
Union Bank	1,48,838	16.80	3.20	844.80	25.10	1.62	19.20	0.90
* At the price band of Rs 85-102; % chg is year on year

Trigger points
The first and probably the biggest trigger is the bank's wide branch network especially in rural and semi-urban areas which can be leveraged to cross selling products once its core banking solutions (CBS) is fully in place.

This could substantially boost its fee income. The bank stands third in terms of branch network with 3,194 branches spread across the country serving 2.5 crore customers with rural and semi-urban areas forming 66 per cent of the total.

Currently, the 324 CBS-based branches form about 35 per cent of its total business. By March 2008, the bank is targeting extending this to 1000 branches constituting 75 per cent of the business. The bank also plans to expand its present ATM network of 261 to 500 by FY08 through tie-ups with VISA and other banks. It also plans to introduce internet banking, SMS/Mobile banking and customer call centres this year.

Trigger two lies in the bank's low credit-deposit ratio of about 65 per cent which gives room to grow in future. The bank plans to grow its advances at 25 per cent this financial year. While corporates will form a major chunk of the loans, proportion of retail and agriculture loans will rise to 13 per cent and 18 per cent from the current 11 per cent and 15 per cent respectively.

Currently, corporates form about 70 per cent of the bank's total advances portfolio. The bank claims that its long standing relationships with corporates like Bajaj and Godrej ensure good fee income in return for services like cash management and bank guarantees.

And then, net interest rate margins, which have been under pressure for the past three years despite a high proportion of low cost funds, are set to rise. H A Daruwalla, chairperson and managing director, says margins will improve to about 3.2 by the end of this fiscal as the ongoing CBS roll-out would lower transaction costs.

Daruwalla joined the bank in June 2005 and has been instrumental in improving the bank's performance partly in FY06 though. The bank plans to leverage its reach in the rural and semi-urban areas for increasing its current and savings accounts (CASA) to 45 per cent of total deposits, from 42 per cent in FY07, besides growing its deposits at 21 per cent. This is trigger three.

Further, Central Bank expects to increase its fee income by 25-30 per cent in this financial year by launching a slew of products including distribution of insurance products and mutual funds. The bank is hoping to utilise some of its 39,000 employees to sell these products aggressively. 
 

KEY OPERATING STATS
	% change
	CAGR (FY04-07)	FY07 (y-o-y)
Net interest Income	5.25	3.96
Other income	-20.99	-10.39
Operating profit	-6.11	5.94
Net profit	-6.95	93.48

Financials and valuation
Looking at the financial performance of the bank in the past three years, one will not be tempted to invest in the IPO. Since FY 2004, the bank's net interest income has grown just 5.25 per cent CAGR with interest costs growing at a higher CAGR rate of about 8.5 per cent.

Also its operating profit and net profit has seen a decline of over 6 per cent each for the same period. Similarly, since the last five years, the bank's deposits and advances have grown at a lower rate than the industry.

Further, non-performing assets at 4.8 per cent gross, and 1.7 per cent net seems high. Also, the bank holds 36 per cent of its investments in 'Available for Sale' category, higher than its peers, which has to be marked to market making it more vulnerable to interest rate fluctuations.

But then, there is some evidence of improvement in the recent numbers. Deposits and advances grew 25 per cent and 38 per cent last year. Net profits almost doubled to Rs 498 crore owing to lower provisions for bad loans.

The future could be different from the past if the management does what it says. For now, analysts are inclined to buy the turnaround story.

Issue opens: July 24
Issue closes: July 27