The Bank of Baroda (BOB) stock is a good ‘buy’ for investors with a three-year holding period. While bad loans have been a problem for most public sector banks, BOB has low net non-performing assets.

At the current price of Rs 635, the price-to-earnings multiple works out to 4.54 times the estimated FY14 earnings.

The stock is also trading well below its estimated FY14 adjusted book value, discounting it by just 0.76 times. The current valuations assume that over half of the restructured assets may be written off and also factor in a very pessimistic scenario on the bank’s prospects — a zero growth in earnings and a fall in return on equity. This scenario is not likely to pan out. Even as BOB’s margins may moderate, profit growth may receive a boost from higher-than-industry loan growth and low costs. Recoveries and upgrades of non-performing assets (NPAs), especially from large accounts, will also support earnings.

A unique aspect of BOB’s business is its growing international loan book (close to 30 per cent) which is mainly trade credit and lending to Indian businesses. This has also helped loan growth.

Thanks to more than Rs 4,000-crore capital infusion over the last two fiscals, BOB has one of the highest core-capital ratios in the banking system. Adequate reserves and internal accruals can support loan book growth for the next three-four years without the bank needing to raise further equity.

The bank’s gross non-performing assets have risen sharply. But with BOB maintaining a high level of provisions against bad loans, future profits are, to an extent, shielded. Given that 60 per cent of the bank’s loans are classified as sub-standard (and entail provisions of 15-25 per cent), the provision coverage, at 80 per cent, is high.

As of June 2012, 87 per cent of the bank’s loan book was secured, up from 80 per cent a year ago. The net NPA ratio of Bank of Baroda is 0.65 per cent, compared with 1.76 per cent for all other public sector banks.

The standard restructured assets account for 6.3 per cent of the book, with no significant loan restructuring expected.

This puts BOB in a better position to make provisions for restructured assets without impacting its profitability.

For the quarter ended June 2012, BOB delivered moderate profit growth of 10.3 per cent due to falling margins and rise in provisions.

The net margins have come under pressure lately, given the rising contribution of international loans and a spike in domestic cost of funds.

The recent cut in the base rate and hike in deposit rates are also expected to impact margins. The management expects to close this fiscal with margins of 2.7-2.75 per cent.

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