SBI: Concerns priced in

Analysts say fears over portfolio quality are already reflected in valuations; and macro improvements, coupled with the expected rights offer, will trigger performance.

The stock of India’s largest bank, the State Bank of India (SBI), which touched a two-year low of Rs 1,831.45 last week, has bounced to Rs 2,002. While its recent underperformance versus the broader market could be largely attributed to concerns over asset quality and a subdued market environment, most analysts believe these concerns largely reflect in current valuations. And, barring unexpected events, the stock should henceforth track the broader market.

Analysts suggest that while SBI’s asset quality would remain under pressure for a couple of quarters, resulting in higher provisions and, thus, an impact on profits, the bank’s net non-performing asset (NPA) ratio to total advances should toe the management-guided level of 1.5 per cent by the end of 2011-12. The pressure on profits due to higher provisioning should be taken care by the growth in top line. That the domestic interest rate cycle is near its peak is also conducive and provides comfort.
 

STEADY GROWTH
In Rs crore	FY11	Q1' FY12	FY12E
Net interest income	32,526	9,700	38,335
NII growth (%) ^	37.4	32.8	17.9
Operating profit *	25,336	7,242	30,119
Profit before tax	14,920	3,086	17,553
Net profit	8,230	1,584	10,883
EPS (Rs)	130.2	-	171.4
EPS growth (%) ^	-9.8	-	31.6
Total CAR (%)	12.0	11.6	11.8
Tier-I CAR (%)	7.8	7.6	7.9
Loan growth (Y-o-Y)	19.8	16.3	16.0
Net interest margin (%)	3.0	3.6	3.0
Casa ratio (%)	49.4	47.9	48.0
E: Estimates,^ Year-on-Year basis,* Prior to provisioning , CAR is capital adequacy ratio                                                                                     Source : IIFL

In this backdrop and the expectations of a healthy loan growth for the bank in the current financial year, they believe the risk-reward equation looks favourable and long-term investors could look at accumulating the stock.

ASSET QUALITY CONCERNS
The asset quality management is the key to the stock’s performance, given that deteriorating book quality has been the key overhang historically, reiterates Mahrukh Adajania of Standard Chartered Research, in a report. She believes that given the weak macro environment, it will be hard for SBI to arrest asset quality deterioration over the next few quarters.

With fresh slippages at Rs 6,180 crore and Rs 5,645 crore in the June and March quarters, respectively, the slippage ratio increased in the former to 3.72 per cent of total advances, compared to 3.52 per cent in the March quarter. Given that the bank hasn’t given a guidance regarding when slippages would peak, this is clearly the parameter in the crosshairs with regard to the September quarter results’ announcement.

The question is how bad the portfolio quality could get. Historical data indicates that the gross NPA ratios reported last quarter are fairly close to five-year highs (3.64 per cent clocked in the June 2006 quarter; averaging 3.04 per cent over the 20 quarters) but well below a peak of 9.37 per cent clocked in the June 2003 quarter. It is difficult to pin down the gross NPL level without company guidance, says banking analyst Murali Gopal, who also believes that slippages would continue.

The view factors in GDP growth of a little over seven per cent and systemic loan growth of 16-18 per cent, in tune with the Reserve Bank of India’s projections. It is at risk only if there is a prolonged slowing and the 2011-12 GDP growth slips below seven per cent. Loans to agriculture and small and medium enterprises have shown higher NPAs and the management has also said it expects stress in the textile sector, attributed to an export ban and lower yarn prices. Gopal is factoring in a gross NPA level of 3.8 per cent for 2011-12 and 1.5 per cent for net NPAs.

Provisioning costs will rise due to both continued slippages and regulatory requirements, mandating 70 per cent provisioning coverage (Rs 550 crore additional provisioning required in the current quarter to achieve this, by IIFL estimates).

TOP LINE CUSHION
Gopal, however, emphasises that the bank’s core operational performance, namely, net interest income (NII), should be strong enough to absorb the provisioning costs from higher slippages, and the underlying theme is that if the top line holds up, the asset quality will hold up.

SBI is expected to showcase a robust top line (NII) growth in 2011-12, outperforming most peers. Analysts estimate a 20-22 per cent growth in SBI’s NII against a 10-15 per cent decline for other banks. IIFL’s banking analyst, Sampath Kumar, believes the bank is on track to achieve net interest margins (NIMs) of 3.5 per cent in 2011-12, as expected by the management on par with its strong performance last quarter (3.6 per cent, with domestic NIMs at 3.89 per cent, the best among public sector banks). This will be driven by higher yields from advances through the prime lending rate (PLR) and base rate increases.

Maturing wholesale deposits should get re-priced at lower rates, trimming funding costs. The banks’ strong low-cost deposit base is an added buffer (current and savings accounts are 48 per cent of all deposits). An added positive is that the bank is emerging from a comprehensive clean-up taken over recent quarters, which should lead to better quality of financials this quarter on.

OUTLOOK
Most analysts believe the stock has priced in a majority of the challenges at the current level of Rs 2,002. A lower slippage trend, as well as concrete news on the bank’s rights issue (which will augment capital to fund future growth), both expected in the second half of 2011-12, are seen as potential triggers. At current levels, the stock trades at a price-to-book (P/Bv) of 1.35 times consensus 2011-12 estimates.