Banks: Credit blues

Lower retail offtake hurts near-term margins.

Banks have been trimming interest rates in a bid to create demand. The latest to do so are State Bank of India and Canara Bank, which have pared their benchmark rates by 25 basis points.

The credit growth in the current financial year has slowed down to 22.6 per cent at the end of January 2007 compared with nearly 30 per cent a year ago. While that in itself is not too worrying, most of the demand stems from companies with retail offtake in low double digits.

Since deposits are repriced with a lag, the immediate impact will be a pressure on margins. Indeed several banks have raised deposit rates recently.

However, there will be some repayment of high-cost bulk deposits in the March quarter and that should help cushion the impact.

Banks tend to prosper in a falling rate environment and while interest rates are not falling sharply, even a moderation in rates could help. Besides, they should post better treasury gains and non-performing loans too should fall, both of which will help boost earnings.

The December quarter saw a good performance by banks with pre-provisioning profits net of trading gains having risen by close to 30 per cent on an average.

With trading returns chipping in, net profits were higher by about 40 per cent. The momentum in fees sustained while loan losses were limited.

Private banks, in particular, saw net interest margins expanding both annually and sequentially.

Bank stocks have done well over the past year with the BSE Bankex outperforming the Sensex during this period.

At current prices, state-owned banks trade at an adjusted price to book value of between 1 and 2 for FY09 book values, while the bigger private banks are somewhat more expensive, trading in a range of 1.7-3.9 times.

Nevertheless, bank stocks should continue to do well in a robust economy.

Biocon: European presence

Biocon's acquisition of a 70 per cent stake in Germany-based AxiCorp for 30 million euros, is at fairly reasonable valuations of 0.5 times enterprise value to sales.

AxiCorp, which markets and distributes generics and allied medical products in western European markets, posted sales of 75 million euros for the 12 months to December 2007.

While not strictly comparable, Dr Reddy's Laboratories had made a significantly larger acquisition, in early 2006, when it bought out the Germany-based Betapharm for 480 million euros, at much higher valuations of about 2.92 times EV to trailing 12 month sales.

Biocon is looking to expand its presence in Europe for biologics and generics and will supply insulin products to AxiCorp.

It hopes to ramp up its sales in Europe from about 25 per cent of its current turnover to 40 per cent over the next few quarters. Biocon sold its enzyme business in July 2007 for $115 million and has adequate cash resources.

Meanwhile, in the December 2007 quarter, Biocon's operating profit declined 23.4 per cent y-o-y to Rs 59 crore, while its operational income fell 3 per cent to Rs 237 crore. Its operating profit margin also declined 640 basis points y-o-y to 24.9 per cent.

The poor performance resulted from a decline in its contract research business on a y-o-y basis. Essentially, some of the contract bookings have spilled over to the March 2008 quarter, say analysts. Besides, the appreciation of the rupee also hurts revenues.

No significant improvement in the company's performance is expected in the short term, add analysts, given the higher R&D costs, capex (leading to an increase in depreciation) and higher expenses linked to the scaling up of the domestic formulations business. Some brokerages have reduced the earnings estimate by 3 to 4 per cent for FY09 to about Rs 27.5 levels.

Biocon is also planning to list Syngene, its contract research subsidiary, which contributed 16 per cent of Biocon's consolidated revenues in the first nine months of FY08 and 18-20 per cent of its consolidated profit after tax.

Biocon has been an underperformer over the last six months, falling 11 per cent compared with a 11.5 per cent rise in the Sensex. At Rs 394, it trades at 14 times estimated FY09 earnings and could continue to underperform.