Oriental flavour

Strong growth prospects and an attractive IPO price should ensure gains in Oriental Bank.

To make more money, you need more money. This is especially true for banks which need capital to grow and explains the flurry of public offers by banks in the recent past. After ICICI Bank, HDFC Bank and Punjab National Bank, it is Oriental Bank of Commerce's (OBC) turn now.

OBC is expected to come out with a public issue of 58 million shares this month, which will haul its total capital to 25.05 crore shares or Rs 250.5 crore. The price band of Rs 275-300 makes it an attractive buy as the stock is trading at a premium even at the higher end of the band.

Even without arbitrage opportunities OBC trades at a trailing P/E of 8.05, on par with peers. But given its solid fundamentals, it deserves better valuations. Considering the issue price, OBC is as cheap as 7-7.6x earnings which is lower than peers. 
 

Financials
(Rs crore)	9 months ended Dec '05 (post-GTB merger)	9 months ended Dec '04	% Change
Interest income	2628.52	2447.26	7.41
Interest expended	1492.79	1386.28	7.68
Net interest income	1135.73	1060.98	7.05
Net profit	523.11	457.39	14.37
EPS (Rs)	27.17	23.76	14.35
CAR (%)	9.40	14.59	-
NPA (%)	1.70	0.00	-

OBC requires more capital to conform to the Basel II norms which are likely to come into effect by December 2006. Basel II norms require banks to assign different risk weights to different classes of assets (read loans) unlike the common risk weightage at present.

If the norms are applied to the bank's existing capital, its capital adequacy ratio (CAR) would be down at least 300 basis points, according to bankers. In others words, the bank will fall short of the RBI-stipulated capital requirement to support its growth in advances.

The bank's merger with Global Trust Bank (GTB) in the third quarter of FY05 put pressure on its balance-sheet in the form of accumulated losses and GTB's loan book. Post-merger, the bank's CAR fell due to GTB's loan book, the surge in its own loan book and lack of extra capital. GTB's capital was used to write off a part of GTB's losses.

The year saw OBC's advances rise 8.5 per cent to Rs 19,897 crore. After the merger, OBC got an additional Rs 2,500 crore into its books (GTB's loan book) which bloated its total loan book to Rs 22,397 crore.

Consequently, its CAR fell 519 basis points to 9.4 per cent - just enough to fulfil the mandatory requirement of 9 per cent. Thus the need to raise capital. After the issue, the CAR is expected to be 300-400 basis points higher than the current level.

After the issue, the government's holding is expected to come down to 51.09 per cent from the existing 66.48 per cent. But this won't prevent the bank from raising more money from the market (though the government would not like to see its stake go below 51 per cent in public sector banks).

According to Sejal Doshi, analyst at Angel Broking, "banks are allowed to raise capital through the preference-share route post-Budget and hence growth will not be impacted."

But the new issue would dilute the bank's capital by 30 per cent. So will the bank be able to post similar earnings growth to keep up its earnings per share? Analysts say it may see a fall in earnings in the first two quarters of FY06 but will make it up given its fundamentals.

The bank is fundamentally strong. It was the first bank to post zero non-performing assets (NPAs); its current NPA level is 1.7 per cent against nil last year. For the nine months ended December 31, 2004, the bank posted a net interest income of Rs 1,135.73 crore, an increase of 7.05 per cent year-on-year, on the back of a rise in interest income.

Profit before provisions and taxes fell 22.47 per cent to Rs 889.2 crore due to a 40.6 per cent dip in other income to Rs 330.81 crore. However, net profit was shielded by lower provisions and taxes and rose 14.37 per cent to Rs 523.11 crore.

The merger has got Oriental Bank accumulated losses of Rs 1,493 crore, courtesy GTB. After adjustment of capital and reserves of Rs 267.28 crore, the net accumulated loss works out to be Rs 1,225.72 crore.

Analysts feel that rather than utilising the new capital to write off losses, the bank may step up provisions. Tax breaks and recoveries of bad loans will also help it reduce losses.

Given the current earnings per share (EPS), the stock trades a 12-month trailing P/E of 8.05 times. Considering a 15 per cent plus growth in earnings for FY06, the stock is attractive.

Moreover, banks are still undervalued compared to other sectors. Given the issue price, which is at a discount to the current price, it's a steal, say analysts.

RESEARCH CALLS

ICICI BANK
(BUY, TARGET PRICE Rs 465)

DSP Merrill Lynch has retained a buy on ICICI Bank after raising the price target to Rs 465, citing loan growth in the sector, amendments in foreclosure norms and the hike in lending rates of mortgages. The stock can trade upto at least 2.3-2.4x FY06E adjusted book (Rs 176), as ICICI Bank is a key beneficiary of stronger loan growth and uptick in asset quality. The price objective also captures the value of its subsidiaries at Rs 55 per share against Rs 47 previously.

MARUTI UDYOG
(BUY, TARGET PRICE Rs 584)

BRICS Securities has initiated coverage on Maruti Udyog with a buy (12-month target of Rs 584). The domestic car industry is set for growth, driven by structural factors. India's car penetration (currently seven per 1000) is expected to expand in the years to come and Maruti will be a beneficiary. A revenue CAGR of 15.8 per cent from FY05-FY07 and an EPS of Rs 44.1 in FY07 is the target.

ITC
(OUTPERFORMER, TARGET PRICE Rs 1,560)

Kotak Securities has retained its outperformer rating on ITC with a price target of Rs 1,560. Cigarette volumes are expected to clock an 8 per cent growth in FY07-14. The estimated size of the Indian cigarette market is at 196-273 billion sticks (versus the current Chinese market size of 1737 billion sticks) despite Indian per capita income equalling the current level in China (in terms of purchasing power parity). Kotak has increased its earnings estimate for FY06 to Rs 91 (Rs 88.3 earlier) and FY07 to Rs107 (Rs105 earlier).

BALLARPUR INDUSTRIES
(OUTPERFORMER, TARGET PRICE Rs 123)

Fortis Securities has maintained a buy on Ballarpur Industries with a price target of Rs 123 (EPS of Rs 12.3 for FY06). Higher demand, better realisations, expansion and savings in raw material costs are the drivers. Domestic demand is expected to grow at a CAGR of 6.1 per cent up to 2008-09 while capacity expansion is estimated to grow at only 3.1 per cent over the same period. With demand expected to outpace supply it will lead to higher realisation. BILT's board has approved a Rs 1,200 crore expansion that will enable it to double the total paper production capacity.