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Suresh Krishnamurthy

Buy IDBI Bank shares

Mr M. Damodaran, Chairman, IDBI... Expansion in spreads holds the key.

INVESTORS desirous of fresh exposure in the stock of Industrial Development Bank of India can consider investing in the stock of IDBI Bank, which is to be merged with the former. Given the performance of IDBI Bank and the expected swap ratio, investing through the Bank would reduce the acquisition cost.

IDBI slows down

In the six months ended September 2004, IDBI's performance has deteriorated. The net interest income is less than one-fourth of that for the 12-month period ended March 2004. For the same period, profits are less than one half, despite the provision for bad loans declining by nearly 90 per cent.

The decline in the financial performance due to poor business growth is of concern. This is because the six-month period ended September 2004 has been favourable for corporate banking. Borrowing by the corporate sector has grown impressively. Perhaps, the initiation of the process of merger with IDBI Bank has consumed organisational resources that could otherwise have been used for business expansion.

The sops offered by the Government and the merger with IDBI Bank have been perceived to enhance value only on the assumption that IDBI's core business can be expanded profitably.

Fortunately for shareholders, there is some degree of improvement in the quarter ended September 2004 compared to the immediately preceding quarter.

IDBI Bank maintains momentum

In contrast, IDBI Bank continued to grow faster. Its customer assets rose 10 per cent over the level at end-March 2004.

This is better than the average for the industry. The net interest income too expanded with the bank able to maintain its spreads. .

On a year-on-year basis, profits rose 27 per cent. As at the end of September 2004, IDBI Bank's contribution to the combined profitability of IDBI has only increased.

IDBI Bank's profits are now more than half of the combined profits. The continued growth of the bank offsets partly the deterioration of IDBI's financial performance.

Valuation, still attractive

The IDBI stock now trades at Rs 86. In the 12 months ended March 2004, the combined profits of IDBI and IDBI Bank were about Rs 450 crore.

Given the decline in profits of IDBI, it is possible that the figure for the 12 months ended March 2005 could stay at about these levels.

Beyond March 2005, the combined entity is expected to report robust growth mainly because of the expected expansion in spreads of the stand-alone IDBI.

In this backdrop, if the share-swap ratio were 1:1 (a favourable one for IDBI Bank shareholders), the earnings per share for the year ended March 2005 would work out to Rs 5.2 and the price-to-earnings multiple about 17.

If the share-swap ratio were less attractive for IDBI Bank shareholders, the earnings per share would be higher. The PE ratio can, thus, be expected to be between 14 and 17. Even at the PE ratio of 17, the valuation is attractive, given the growth possibilities.

Investors, however, can consider acquiring the shares of IDBI Bank. At Rs 44, the market is factoring in a swap ratio of 1:2.

There is a strong likelihood that the swap ratio would better than this. If that happens,, the cost of acquisition of IDBI shares would come down, giving investors a higher margin of safety.

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