Public sector bank stocks have shot up in the last six months, on hopes that their growth and loan quality concerns will abate on an economic recovery. But we believe that the time may be ripe to book profits on some of these stocks given the structural risks to the business.
Union Bank, is one such stock that has run up sharply in the past six months, gaining 42 per cent and re-rating from a price to adjusted book value of 0.8 times to 1.1 times (close to its historical average of 1.2 times). However, this may be a good opportunity to lock into these gains as the stock price gains may cap the returns from here. Union Bank has a higher exposure to infrastructure and power sector within PSU banks and has seen a trend of increasing restructured assets too. The return on assets remains low within the space at 0.68 per cent during the nine months ended December 2012. This means the bank will require more capital infusion, especially with its capital adequacy at 10.8 per cent, again one of the lowest within the PSU banks. The growth in the bank’s corporate loan book has been driven mainly by its increasing exposure to the infrastructure sector. The share of infrastructure in the loan book grew from 11 per cent in March 2011 to 17 per cent as of December 2012. In a bid to tide over the sluggishness in corporate loans due to economic slowdown, the bank has started to focus on small and medium enterprise and agriculture. This is risky given the high loan delinquency in these sensitive sectors. Between March and December 2012, loans to agriculture grew 18 per cent and contribute 10 per cent of the loan book.
It has seen major loan quality deterioration, with its gross non-performing assets growing 26 per cent in the first half of FY2013. This resulted in higher provisioning cost impacting profitability of the bank, with its net interest margin under pressure. After two quarters of continued stress, the quarter ended December saw some relief with gross non-performing assets moderating to 3.4 per cent from 3.7 per cent in the previous quarter. However, it needs to be seen if this improvement is sustained.
The bank’s restructured assets are at 5.6 per cent of the loan book. The management has guided for an increased level of restructured loans in the coming quarters, taking the number to 8 per cent by the end of FY 2013. With the slowdown still on, and loan quality concerns in sectors such as infrastructure and agriculture still quite high, the stock appears fully priced.