The Hindu Business Line : Andhra Bank: Avoid

AN INVESTMENT in the public offer of Andhra Bank can be avoided. The offer is priced stiffly and the downside risks are high. An entry into the stock can be considered when the valuation is more attractive.

Andhra Bank's performance in the first six months of FY-06 has not been encouraging. The bank reported a 31 per cent growth in advances year-on-year for the September quarter.

This, however, belies the fact that the actual growth in advances in the quarter-ended September was below the industry average. Advances growth between March and September was three percentage points lower than the industry average of 10 per cent.

There are also indications of erosion in spreads. For the quarter ended September, the net interest income registered a modest increase of 4 per cent. A more-than-proportionate rise in interest expense compared to interest income narrowed the net interest income.

The relatively lower share of low-cost deposits is a cause of concern for the bank. The borrowing cost has also risen by about 170 basis points, putting pressure on margins. However, that the share of savings deposits is steadily increasing in total deposits is a positive in this regard.The bank's `other income' is a damper on its profitability.

Fee income, the key

With treasury buffer thinning and margins likely to remain under pressure over the next few quarters, fee income would hold the key for the bank's profitability. For the quarter-ended September, fee income has risen 30 per cent. The bank expects to focus aggressively on selling third-party products. It might, however, find it challenging, as competition from larger public sector and private banks is likely to intensify.

Flat margins likely

Over the past few months, the bank's net interest margins (NIM) have contracted and this has shown up in its quarterly results. With yields on advances and investments declining, any improvement in margins appears unlikely. In terms of interest rate risk, the investment portfolio of Andhra Bank appears insulated to a large extent, as the bank has transferred a substantial portion of its portfolio from available-for-sale to held-to- maturity category.

Focus on retail lending

The bank has, over the last few years, increased its focus on retail banking. With retail loans constituting about 20 per cent of gross advances, there is still considerable room for growth. Housing loans, in particular, have grown at a faster pace. Again, the focus on housing finance, which now accounts for half its retail assets, may not improve margins. In addition, if the Reserve Bank of India raises capital adequacy for housing finance to 100 per cent, the capital required would increase for Andhra Bank, reducing profitability further.

Improved asset quality

There are several positive aspects that cannot be ignored. On the asset quality, there has been remarkable improvement. A combination of recoveries and higher provisioning has helped Andhra Bank contain its non-performing assets.

The bank's net NPAs, as a proportion of net advances, is among the lowest in public sector banks. If recoveries proceed apace and the accelerated retail lending does not create fresh bad loans, Andhra Bank may bring down net NPAs to zero by the first half of 2006-07. Being one of the smaller public sector banks, Andhra Bank has shown robust growth. It is one of the most profitable banks in the country, with a return on net worth in excess of 20 per cent in each of the past five years.

Richly valued

At its current price of about Rs 105, the stock trades at a price-to-earnings multiple of about nine times its trailing 12-months earnings and a price-to-book value of close to two. This appears stiff compared to the likes of Allahabad Bank and Canara Bank, which are trading at a price-to-book value of about 1.2-1.4 times.

Even at Rs 82, which is the lower end of the price band, the stock is valued at a premium to a number of its peers. Although Andhra Bank's business growth has been strong, erosion in margins seen in the first half has reduced earnings visibility.

There are also many other small/medium-sized public sector bank stocks trading at relatively more attractive valuation. It may thus be better to avoid the offer now and consider investing when valuation is more appropriate. Also, with a dividend yield of about two per cent, downside protection is also limited.

Offer details: On offer are 8.5-crore shares. The issue opens on January 16 and closes on January 20. Post-offer, the government holding would fall from 62.5 per cent to 51.5 per cent. SBI Capital Markets and Citigroup global are lead managers to the issue. Andhra Bank has fixed a price band of Rs 82 to Rs 90 for this offer.

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