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Suresh Krishnamurthy

Mr S. C Gupta, CMD, and Mr Rohit M. Desai, Executive Director -- Adopting a conservative stance.

FRESH investments can be considered in the stock of Indian Overseas Bank (IOB). In terms of relative valuation parameters, the bank's stock is not undervalued; it is not richly valued either as it trades at a price-to-book value of close to 1.25 times.

IOB is, however, growing fast and its operating parameters improved significantly in 2003-04.

Widening spread

The impressive aspect of IOB's performance for the year-ended March 2004 was the large growth in spreads.

Spreads, which refer to the excess of lending over borrowing rate, expanded from 3.14 per cent to 3.62 per cent. Very few public sector banks have till now reported this order of expansion in spreads.

With advances growing at 16 per cent, the improvement in spreads helped the bank record a 30 per cent increase in net interest income.

The bank's yield on advances, which is above 10 per cent, is higher than that that ofmany of its peers. This gives it a cushion in the event of sustained pressure on margins. Like most public sector banks, IOB has been able to compress growth in operating expenses too, which rose by only 7 per cent in 2003-04.

With increasing contribution from non-interest income, partly aided by a rise in profits from the sale of investments, operating profits rose a significant 67 per cent.

At the net level, IOB's profits improved only 23 per cent because it chose to raise the provision coverage for bad loans; the provisions for bad loans are over and above what is mandated by RBI guidelines.

Its record in management of bad loans also improved in 2003-04. Recoveries, as well as upgradation, of loans classified as bad have increased in 2003-04.

Targets for 2004-05

The bank's targets for 2004-05 are as follows:

Bring down the gross non-performing assets by as much as it did in 2003-04.

Even if the spreads do not improve, a combination of volume growth and improvement in the credit-deposit ratio should help boost growth in the net interest income beyond 15 per cent. In addition, if the gross non-performing assets position improves, the level of provisions required will also be lower.

Given that the bank is still sitting on sizeable unrealised gains, the level of treasury profits is unlikely to decline.

If it decides to book profits in anticipation of a rise in interest rates, the contribution of treasury profits will only improve.

In this backdrop, maintaining a profit growth of 20 per cent in 2004-05 will not be difficult. The growth rate may be higher if the provisions for bad loans are significantly lower and spreads improve marginally.

Reasonably valued

At Rs 45, the IOB stock trades at a price-to-earnings multiple of less than five times its earnings for the period ended March 2004.

Considering the expected growth rate in earnings, the stock is not stiffly valued. In terms of dividends, the yield works out to about 4.4 per cent.

The bank is expected to become eligible to declare dividends without the need for RBI approval in 2004-05. That, however, may not lead to any sizeable increase in dividends.

If the past is any indication, then dividends can grow to Rs 2.40 per share from the present Rs 2 per share.

That would peg the dividend yield at a level higher than 5 per cent. This should allow for reasonable downside protection in this volatile market.

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