The Hindu Business Line : Bank of Baroda: Invest at Rs 230

INVESTMENTS in the public offer of Bank of Baroda can be considered at the higher end of the price band. The stock is under-valued relative to its fundamental strengths. The valuation reflects the bank's poor performance in the period 2002-2005 and does not factor in the improvement in financial performance over the past 12 months. Given the low expectations underpinning the stock valuation, investments in this offer have a lower downside and the potential to deliver returns commensurate with risk.

Modest show

Between 2002 and 2005, everything that could go wrong with Bank of Baroda did. While most banks were utilising windfall gains on the government securities front to emerge stronger, Bank of Baroda was beset with problems of poor growth in advances and below-average improvement in bad loans. The bank's technology initiatives were also off to a slow start.

Between 2002 and 2005, the bank's advances grew at a rate below the industry-average. Banks such as Punjab National Bank, Bank of India and Canara Bank, once considered peers, grew faster and now sport a larger advances portfolio. Union Bank of India, once a relatively smaller bank, has now managed to catch up with Bank of Baroda in terms of size of advances.

In the case of bad loans, most banks succeeded in bringing down the proportion of gross bad loans to a level below the 6-per cent mark. Allahabad Bank, classified as a weak bank earlier, was able to bring down bad loans to less than 6 per cent of advances by March 2005. The State Bank of India, which had large bad loans consistent with its size, also managed to bring down bad loans from 11.95 per cent at end-March 2002 to 5.96 per cent by March 2005. In contrast, Bank of Baroda managed to reduce bad loans only from 12.39 per cent to 7.30 per cent.

The bank's technology initiatives compared poorly with peers. Progress in the implementation of core banking solution and opening of ATMs was tardy. Punjab National Bank and Union Bank of India were off the blocks faster in this regard. This also reflected in their relatively superior growth rates.

On the mend

The situation is, however, on the mend now. Domestic advances growth at 33 per cent in the 12 months ended September 2005 is higher than industry average of 30 per cent. Advances of international branches, which constitutes a sizeable 18 per cent of total advances, is also growing at a healthy 15 per cent.

Net interest income (difference between interest income and interest expenses) is also growing at about 12.5 per cent. The lower growth in net interest income relative to advances growth clearly indicates the pressure on margins. What the bank has achieved is, however, superior to what most other public sector banks have managed during the same period. On the bad loans front, gross non-performing assets fell 15 per cent over the past 12 months.

Given the success in recent initiatives, optimistic scenarios that the bank is aiming for are:

Decline in bad loans to less than 5 per cent by March 2006;

Achievement of return on assets of one per cent plus by March 2006;

Implementation of core banking solution in about 600 branches by June 2006 and an increase in the number of ATMs to 600 by March 2006;

A long-term target of a doubling in assets size by 2009.

Opportunities and threats

In the second half of financial year 2005, Bank of Baroda charged close to Rs 1,000 crore against profits. This artificially brought down profits for that period. On that smaller base, the bank is set to report growth in profits of about 100 per cent. That would be the case even if provisions against bad loans and depreciation in value of government securities continue to be high.

If the bank is able to maintain the growth rate in advances and stabilise the decline in margins, potential for profit growth could be even higher. Odds, however, favour the bank reporting profit growth of about 100 per cent in the second half of FY-06 and follow it up with profit growth of 25-30 per cent in the following year. Profit growth in 2007 could touch 25 per cent even with modest return on assets of 1 per cent.

The primary threat to profit growth stems from a sharp hike in interest rates. Bank of Baroda would have to charge to profits any depreciation in value of about 47 per cent of its investment portfolio. The investment portfolio would depreciate in value if the yield on government securities keeps rising. As of now, probability is only for a steady, and not sharp, rise in yields. This mitigates the potential threat. In addition, the impact of a sharp hike a year down the line would be significantly less than an increase three months from now.

Another factor is a growth in bad loans. This is an issue that will affect all public sector banks. Similar to trends between 1994 and 1996, industries such as steel, textiles and chemicals are now borrowing substantially from the banking system. In addition, loans to the agriculture sector are also rising sharply. If things turn sour in these industries again, then the proportion of bad loans would rise, affecting financial health of banks considerably.

An offsetting factor is growth of loans advanced to infrastructure and retail. Since these loans are also growing faster, the advances portfolio of banks is far more diversified now than they have ever been. The bad loans scenario, nevertheless, needs a close watch.

Attractively valued

At the prevailing market price, the stock trades at a price-to-book value of less than 1.2 times. Notwithstanding the low return on assets of about 1 per cent-plus that the bank seeks to achieve, a price-to-book value of about 1.5 appears justified. This is based on expected returns of about 12 per cent from an investment in the stock. If one seekS lower returns, the stock would appear even more attractive.

If profits grow at moderate rates over the next two years, the stock would also turn into an attractive dividend play. At the current market price, the dividend yield for the forthcoming financial year could turn out to be about 3 per cent. Since this dividend can only grow at a steady rate, a re-rating of the stock would also then be on the cards. Investors with a two/three-year perspective can consider buying into the stock.

More Stories on : Public Offer | Recommendation | Public Offer

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page