The Hindu Business Line : Bank of Baroda: Buy

AN INVESTMENT in the Bank of Baroda stock can be considered. The stock is trading at a price to earnings multiple of nearly 10 times its earnings for the period ended March 2005. Earnings were depressed due to large provisions arising from depreciation in the value of investments.

For the current year, the earnings are expected to rise on the back of improved business growth and lower provisions.

Considering that banking and financial services are expected to benefit from the growth of the economy, the longer-term prospects for a large bank, such as Bank of Baroda, also appear bright.

Bank of Baroda has been one of the under-performers among public sector banks. Business growth over the past few years has been disappointing. Large investments in government securities have left the bank vulnerable to rise in interest rates.

When interest rates did rise in 2004, Bank of Baroda was one of the worst hit. This under-performance is also reflected in the stock price. Over the past 12 months, bank stocks have generally risen by about 90 per cent. But the Bank of Baroda stock managed only a 49 per cent rise. In the past three months, however, Bank of Baroda has emerged as one of the out-performers. The trigger for the resurgence in the stock price was the return of stability to interest rates and the improved performance of the bank.

With interest rates generally expected to remain stable, Bank of Baroda should report above-average growth in advances. Its chairman has indicated that growth in advances for FY 2006 would be about 25 per cent. These two factors indicate that profit growth in FY 2006 would be robust. If net interest income rises by about 10 per cent over FY 2005 and provisions decline by 30-40 per cent, then profit growth could be around 50 per cent. Since an upswing in investments is expected in FY 2007, earnings growth in the succeeding financial year is also expected to be impressive. However, the stock trades at a substantial discount to its peers. This is the only large public sector bank to trade at a price-to-book ratio of less than 1.

There are several other positive factors. Bank of Baroda has made considerable progress in reducing the proportion of bad loans in its portfolio — one of its weak areas. It also fares better on the capital adequacy front compared to other public sector banks.

It has considerable leeway to mobilise long-term loans to enhance its capital adequacy — the bank is already exploiting this advantage.

The Government stake in the bank is also high, at 67 per cent. This allows the bank to raise funds to accommodate growth.

Risks to the recommendation arise principally from an increase in interest rates. The bank's government securities portfolio remains relatively more vulnerable to an increase in interest rates compared to other public sector banks.

The probability of that risk materialising in the next 6 to 12 months appears modest while the prospect for business growth appears encouraging. These factors make Bank of Baroda a compelling valuation play.

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