Bank of Baroda: Buy

Fresh investments with a two-to-three year investment horizon can be considered in the stock of Bank of Baroda (BoB). The Reserve Bank of India's decision to cut the cash reserve ratio (CRR) and signals of lower rates may provide a leg up to the banking sector. Bank of Baroda delivered good profit growth in the December quarter.

Though non-performing assets (NPA) increased, its loan book after provisioning continues to be the best in terms of asset quality for a public sector bank.

Apart from superior asset quality, BoB enjoys better operational parameters compared to most of its peers. Its business per employee and profit per employee are among the best in the banking system.

At the current price of Rs 759, the stock trades marginally higher than its FY13 adjusted book value (adjusted for pension liabilities and NPAs).

This valuation seems to be very low for a bank which has consistently clocked a return-on-equity in excess of 18 per cent (even after capital infusion by the government reduced the leverage).

The price-to-earnings multiple for BoB at 5.3 times for FY13 is also low. The bank may continue to clock double-digit earnings growth, driven mainly by balance-sheet growth (especially overseas business).

Higher levels of capital adequacy will allow it to grow at higher than industry rate of growth.

The bank continues to gain market share without diluting its profitability. The market share in domestic advances of BoB has improved from 3.53 per cent in March 2007 to 4.01 per cent in March 2011 to 4.09 per cent in December 2011.

The fee income contribution of the bank is low and leaves a lot of scope for improvement.

International business

Overseas loans account for about 30 per cent of its loan book and have aided the overall loan book growth. As of December 2011, Overseas loan book grew at 44 per cent year-on-year. Even after adjusting for rupee depreciation, the growth was 22 per cent.

BoB benefitted from the increased appetite of Indian companies for external borrowings and from trade credit. Therefore, even as domestic business for bank moderated, BoB's overall loan book growth remained strong.

Overseas business contributed to 19.6 per cent of the total gross profits for the nine-months ended December 2011. Positives have emerged from overseas business as margins improved sequentially.

The net interest margin (NIM) improved from 1.41 per cent in the March 2011 quarter to 1.64 per cent in the December quarter.

Low NPAs, lower cost-income ratio and high fee income contribution make up for the low margins of the international business.

Comfortable Capital adequacy

Accounting for profits added into net worth and an additional capital infusion of Rs 675 crore by the Government (Government plans to increase its stake in the bank to 58 per cent from 57 per cent), the tier-1 ratio of the bank may improve to more than ten per cent. In the case of other public sector banks, the tier-1 ratio is closer to 8 per cent.

Such high levels of capital adequacy may take care of its requirements for at least three years, even after assuming a higher than industry rate of growth in assets. Therefore, BoB can continue to gain or at least maintain its market share.

Capital adequacy ratio of BoB was at a comfortable 13.45 per cent at the end of the Dec-11 quarter, without taking into account the first nine months of profits that may add another 15 per cent to the Tier-1 capital.

December quarter surprises

The December quarter NIM of BoB's domestic business have declined as the yields didn't rise as much as the cost of funds. Deposits getting re-priced at higher rates was the reason for higher rise in cost of funds.

In spite of decline in NIMs, the net interest income witnessed a 15 per cent rise thanks to a strong growth in assets. Sharp jump in other income and curtailed operating expenditure led to gross profit growth in excess of 40 per cent.

Such high rate of growth in gross profits didn't translate into higher net profits due to a sharp jump in provisions for investment depreciation and NPAs.

The NPAs of BoB rose by 15 per cent sequentially taking the ratio to 1.48 per cent of advances. The rise in NPAs was partly driven by restructured portfolio. However, after provisioning, the bank has a net NPA ratio of 0.51 per cent, which is still low.

The restructured asset proportion has risen for BoB to 3.8 per cent of the overall loan book. At 3.8 per cent of the loan book, the ratio continues to be among the lowest in the public sector bank space. Around 13 per cent of the restructured assets till December have slipped into NPAs, which is also lower than other peers.

Restructured assets were mainly from infrastructure, telecom and small and medium enterprises. With revival in the economy, this portfolio may perform normally.

However, any higher slippages from this book can further affect its profitability.