The Hindu Business Line : Allahabad Bank: Buy

An investment can be considered in the Allahabad Bank stock at Rs 75. The stock remained defensive in the recent round of correction, shedding about 16 per cent against the broad market slide of 30 per cent. Impressive performance, stable earnings outlook over the medium term and undemanding valuations strengthen the case for investment. Investors, however, have to tone down their return expectations, as we believe it is going to be more moderate. The Allahabad Bank stock continues to hold the potential to deliver returns commensurate with the risks involved.

Attractively valued

The stock, at its current price, trades at a price-to-book value of one and a PE multiple of about 4.5 times its trailing 12 months earnings. This appears attractive compared to Canara Bank and Andhra Bank that are trading at 1.2-1.3 times their book value. The bank has been able to maintain its return on assets at 1.3 per cent over the last few years. We believe that there may be a marginal slip in its return on assets on account of rising cost of funds and tightening of credit. The bank has stepped up its dividend payments to 40 per cent in FY-06. Its dividend yield at 5.3 per cent is healthy and, thus, offers cushion to valuations.

Impressive performance

Allahabad Bank has recorded impressive performance across several vital business parameters in FY-06. Its showing on advances and deposits has been strong; while the former rose by over 35 per cent, deposit accretion was 19 per cent — on a par with the industry average. What is even more important is that the loan growth has been all-round, with all four key segments — agriculture, retail, SME and corporate — growing by about 35 per cent.

The credit boom seen over the last two-three years has helped banks increase their retail assets. However, with banks now having to provide for additional capital towards housing and real-estate lending, we believe growth in this segment is likely to slow down. On the positive side, banks are increasingly turning to rural financing, which is expected to be the next frontier. Higher volumes in farm credit, in particular, are expected to help banks record healthy business growth. In this backdrop, we believe Allahabad Bank, with its long-held advantage in farm lending, is well-poised to cash in on the opportunity.

Margins to remain stable

The bank's net interest income rose 16 per cent in FY-06. The net interest margin (NIM) remained under pressure during the first nine months which resulted in the bank registering a contraction of about 25 basis points in its NIM of 3.1 per cent for the full year. Margins, however, improved in Q4 due to repricing of loan assets and a rise in investment yields. In the near/medium term, NIMs are likely to remain stable. Incremental cost of raising funds is expected to go up by about 50-75 basis points while incremental yields on investments are likely to decline or at best remain flat.

For Allahabad Bank, a relatively higher proportion of low-cost deposits are a positive in this aspect. With close to 40 per cent of its deposits under the low-cost category, the bank is relatively better placed to protect its margins.

Focus on fee-based income

Mr O. N. Singh, CMD

Low component of fee-based income has been an area of concern for Allahabad Bank over the years. This, however, appears to be changing slowly. The pace of growth has indeed been impressive.

In FY-06, the fee income rose by over 60 per cent. Its increasing thrust on cash management and wealth management services is likely to auger well for its growth.

The bank has tied up with insurance companies and mutual funds for cross-selling their products. This again is expected to bolster its fee income. On the flip side, tough competition from private and foreign banks, among others, which are aggressive in this area may act as a constraint.

The bank is also eying a share in the global business. It recently set up a branch in China — a market that promises potential for bankers worldwide. It may, however, be too early to take a call on its overseas operations, given the challenges involved in operating in untested waters.

Adequately capitalised

Following the follow-on public offer in April 2005, Allahabad Bank's capital adequacy ratio improved to 13.4 per cent from 12.5 per cent a year ago. The bank's board has approved the proposal for raising about Rs 500 crore in FY-07.

In addition, the bank has the leeway to convert about Rs 450 crore from its Investment Fluctuation Reserve into Tier-1 capital. As such, we believe the bank is well-equipped to meet Basel II norms and fund growth.

Key concerns

About 50 per cent of the bank's investment book is under the Available for Sale category, making it vulnerable to interest rate risk. The bank has suffered marked-to-market losses of about Rs 200 crore in FY 06.

A good number of macro-economic factors point towards hardening of interest rates in the near term. This further exposes the bank's financial statements to the risk of loss due to rising interest rates. Also, uncertainty revolving its proposed non-life joint venture with Sompo Japan Insurance, following the grant of a business suspension order to its overseas partner, also remains a concern.

More Stories on : Stocks | Recommendation | Public Sector Banks

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