The Hindu Business Line : Dena Bank: Buy

INVESTORS with a penchant for risk can consider taking exposure in the stock of Dena Bank (Rs 32). Without a capital infusion within the next 12 months, the prospects for Dena Bank appear bleak. The decks appear to be clearing up for such an event.

Capital infusion, especially without any equity expansion as would happen if funds were raised through a preference share issue, could lead to a re-rating of the stock. Besides, the stock market loves a turnaround story. Share price gains in most such cases would be attractive. Invest with a one/two-year perspective.

Legacy costs

Banks have generally had a good time, with robust business growth over the past twelve months. That is true for Dena Bank as well. Its business growth has been impressive and non-performing assets declining steadily. The bank does not, however, have anything to show in terms of profit growth. In the half-year ended September 2005, it reported huge losses. The loss underscores the difficult period the bank had to go through over the past few years because of unrecoverable loans. In the half-year ended September 2005, the portfolio of government securities proved to be a bane for most banks. They had to contend with a decline in profit from sale of investments and charges to reflect the depreciation in the value of government securities.

Most banks were able to lower the charge for unrecoverable loans. That cushioned the impact of the rise in interest rates on government securities, which reduced their value. Dena Bank still had to provide a hefty Rs 15 crore for non-performing assets.

Bad to better

Dena Bank's balance-sheet is, however, now largely clean and shareholders can hope for better days. The gross advances growth has been more or less in line with that of the banking industry, which has been growing at about 30 per cent.

In addition, there has been a marginal increase in the net interest margin (the difference in the rate at which money is borrowed and lent). Improvement in volume growth accompanied by rising margins is a recipe for increase in profits. In the half-year ended September 2005, operating profit did grow by 45 per cent.

Over the next six months, the reported financial performance would acquire sheen even without such improvement. In the six months period ended March 2005, the bank made provisions for Rs 241 crore.

The `other income' too was low at about Rs 124 crore. Also, banks had to contend with issues such as wage arrears. Without such burdens, the performance in the half-year ended March 2006 is bound to be impressive on a relative basis.

Capital constraints

So with the short-term outlook so bright, why is the stock market not taking note? It is probably due to capital constraints. Dena Bank's capital adequacy was about 9.3 per cent at end-September 2005 and government holding at 51 per cent. A public offer of equity is, therefore, ruled out.

If laws were not amended to allow banks to mobilise funds through the preference share route, their businesses would come to a standstill.

Considering that amendments to crucial pieces of legislation have often run into trouble, only risk-seeking investors would buy the stock. With a Standing Committee of Parliament in favour of such an amendment, the prospects for public sector banks such as Dena Bank have brightened. Investors now have a chance to take positions before the proposal becomes law.

The stock is also attractively valued. The price-to-book ratio is only about one. Any dividend is unlikely over the next six months.

Still, even with a paltry return on asset of about one per cent, the dividend the following financial year could be about a rupee per share. That would work to a dividend yield of 3.2 per cent on the present market price. In addition, the returns could be even better if Dena Bank were to squeeze out a return on asset of about 1.25 per cent.

Apart from a delay in amendments to banking laws, there are other risks. If a merger is put through between Dena Bank and another public sector bank before the banking laws are amended, the returns to shareholders may be limited.

In addition, if there is a sharp spike in interest rates in the next three months, bank stocks may languish. The probability of these risks materialising now seem small and an investment in the stock can be considered.

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