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Suresh Krishnamurthy

Mr O. N. Singh, CMD... Improving asset quality.

AN INVESTMENT in the book-built public offer of Allahabad Bank can be considered at Rs 82. The bank is offering 10 crore shares in the price range of Rs 75-82. The offer closes on April 12.

At Rs 82, the stock is attractively valued relative to its peers. The bank's performance over the past three years has also been impressive with considerable improvement in its balance-sheet strength. If the bank continues to report such robust growth, the return for the shareholders would be more than commensurate with the risk involved.

The public offer would also place the bank in a strong position from the perspective of risk. Bad loans would become a manageable proportion of shareholder funds and the capital adequacy levels would be high. The bank would, thus, be comfortably placed to accommodate growth and changes in regulations requiring higher capital.

The public offer is also likely to enhance the shareholding of institutional investors in the company. Apart from LIC, the holding of institutional investors in the company has been low with total FII holding at less than 2 per cent. A higher degree of interest from institutional investors would also lead to better price discovery.

Shrinking bad loans

The change in the perception of Allahabad Bank, from a weak bank to one that is consistently gaining market share, has happened in a short time frame. At end-March 2002, bad loans were higher than the bank's shareholder funds. After this public offer, bad loans or non-performing assets would be about 10 per cent of shareholder funds — a remarkable turnaround in three years.

Non-performing assets are advances on which interest or principal has been due beyond 90 days. The proportion of gross NPAs to gross advances came down from 17.7 per cent at end-March 2002 to about 8.7 per cent by end-March 2004.

Significantly, the improvement has sustained in fiscal 2005, with gross NPAs declining to 6.2 per cent. Most other public sector banks have not reported such significant reduction in NPAs in fiscal 2005.

Robust growth

Business growth too has been strong. In the years ended March 2003 and March 2004, Allahabad Bank reported business growth of about 20 per cent. This was higher than the average growth rate in the industry, which was at 15 per cent.

The performance in fiscal 2005 has been even more impressive. In the nine months ended December 2004, Allahabad Bank's advances rose 26 per cent while that of the industry grew 16 per cent.

Allahabad Bank also had to provide for losses on its portfolio of government securities in fiscal 2005. Yet, the bank has reported strong growth in profits. Profits for the nine months ended December 2004 are already equal to the profits for FY-04. Although there may be a flat trend in profit growth in the quarter ended March 2005, Allahabad Bank is set to report growth in profits for FY-05. As 2005 has been a tough year for banks, this is an achievement.

Discount to peers

In fiscal 2006, the bank can generate a return on shareholder funds of about 25 per cent. That would produce a profit growth rate of about 20 per cent for that year. If favourable business conditions persist, the bank can aspire for even higher growth. This rate of growth compares favourably with the stock valuation.

After the public offer and the earnings for FY-05, the net worth of the bank would be about Rs 3,000 crore and the book value per share about Rs 65.

The earnings per share for the year ended March 2005 would be about Rs 14. The bank might end up declaring a dividend of Rs 3 per share for FY-05. At Rs 82, the stock offers a dividend yield of 3.7 per cent, trading at 1.25 time book value and at a P/E of six.

The valuation is not demanding and is at a discount to many of its peers. If the bank manages to grow its profits at an average 10 per cent over the next five years, the potential for growth in dividends and wealth generation would be considerable.

Considering the expected growth in the economy, this appears achievable.

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