South Indian Bank

Marching northwards

The South Indian Bank (SIB), by its name, reveals its strong presence in south India. Of its 432 branches in 17 states, 220 are in Kerala and 93 in Tamilnadu. As of December 2005, nearly 87% of its business was networked under the core banking solution.

SIB has started its network in north Indian cities like Amritsar, Ludhiana and Bhopal. Approvals for more than 20 other branches are pending with the Reserve Bank of India (RBI).

An old private sector bank with no identifiable promoters. ICICI Bank, which holds 10.73% of SIB’s pre-issue equity capital, has to bring its shareholding down to 5%, as per RBI guidelines.

SIB had come out with a rights issue (1:3 at Rs 40) in July 2004. The main objectives of the current offer include augmenting the capital base to meet the future capital requirement arising out of the implementation of the Basel II standards. On September 2005, SIB’s capital adequacy ratio (CAR) stood at 10.28% as against the RBI-stipulated 9%.

Strengths

• Good progress has been made in de-risking the investment portfolio from future rise in interest rate.

• SIB has signed a memorandum of undertaking with Hadi Express Exchange Company to provide management services to its NRI clients in Gulf countries. It is a pure fee-based revenue mechanism to provide a single-window facility to NRIs.

Weaknesses

• The net NPA ratio of 2.4% as on December 2005 leaves scope for improvement. Moreover, SIB has a high concentration of its loan and NPA portfolio among certain customers and sectors. As per prospectus, the single largest borrower accounted for approximately 14.32% of its capital funds, while the largest borrower group accounted for 13.09% on September 2005,

Valuation

In nine months ended FY 2006, SIB’s net interest income witnessed a growth of 18% to Rs 230.37 crore. The other income fell by 38% to Rs 43.13 crore. The provisions and contingencies were down by 48% to Rs 58 crore. After providing for tax, at Rs 11.60 crore, the profit after tax was Rs 34.59 crore, up by 243%.

The last two years were extremely bad for SIB’s profit. Hence, this year’s recovery is on low base.

The last one-year, six- and three-month average price of the stock was around Rs 68.

The offer price band is Rs 60-66. At Rs 60, PE on nine-month annualised EPS of Rs 6.3 (on post-issue equity capital of Rs 72.68 crore) works out to 9.5. At Rs 66, PE on its nine-month annualised EPS of Rs 6.5 (on post-issue equity capital of Rs 70.41 crore) works out to 10.1.

Considering the price of Rs 66, post-IPO book value (BV) is Rs 86.0 and adjusted book value (ABV) Rs 61.0. P/BV is around 0.8 and P/ABV around 1.1. In a normal market, SIB will trade around a P/ABV of 1.

The banking sector needs consolidation and small regional banks without strong promoters, such as SIB, will have to ultimately merge with stronger and larger players once the government policy supports such moves. Till then they will have to survive and try hard to keep their presence felt in a highly competitive scenario.

Indo Tech Transformers

Indo Tech Transformers (ITT) manufactures distribution transformers and power transformers. The company currently has three plants. Two are located in Chennai, Tamil Nadu, and one in Palakkad, Kerala. These three plants manufacture 500 –600 transformers of assorted sizes every month. They have an overall annual capacity of 2,450 MVA.

The key customers of ITT include state electricity boards (SEBs), engineering, procurement and construction (EPC) contractors, and the corporate sector. The company has also exported transformers to Nigeria, Srilanka, UK, US, Ghana, and Canada.

The net proceeds from the issue, after meeting issue expenses, will be utilised to:

*Relocate and modernise the Saidapet plant into a new distribution transformer plant of 750 MVA / annum at Thirumazhisai.

*Set up a new power transformer plant with a capacity of 2,400 MVA per annum including 220 KV class of transformers.

*Put up a 120-unit per annum dry-type transformer plant at Thirumazhisai.

*Meet the working capital requirements of the company.

The expected date of commencement of production of the distribution transformer plant, power transformer plant and dry-type transformer plant are 15 August 2006, 1 April 2007 and 20 June 2006, respectively.

Strengths

• The Union government’s emphasis on providing power for all by 2012 and reform initiatives including the accelerated power development and reforms programme (APDRP) is likely to benefit all organised electrical equipment manufacturers as there will be a thrust on quality products. About 1,00,000 MW of power generation capacity is likely to be added by 2012. For every 1MW of new capacity that comes up, 7-MVA transformers are used across generation, transmission and distribution segments. This implies a demand of 700,000 MVA of transformers unfolding over the next five years. This will result in an annual demand of about 1,40,000 MVA.
• Transformers usually have a life of 20-30 years. Hence, transformers installed in the 1970s and 1980s are likely to be replaced in the next few years. On an average, about 67,517-MVA transformer capacity has been added annually in the sixth five-year plan(1980-85). Since the life of these transformers exceeds 20 years, they are likely to be replaced.

• The commissioning of the proposed 2,400-MVA transformer plant will enable ITT to manufacture power transformers of higher range: 132 KV and 220 KV class of transformers. The margin in the higher end of transformers is better and competition is less as more technical knowledge is required.

Weaknesses

• ITT will lose the benefits it enjoys as a small-scale unit when the proposed projects are implemented. Once it loses this status, the company will not be entitled to the price preference that is available to small-scale manufacturing units for supply of equipment to the Tamil Nadu Electricity Board (TNEB). This is likely to shave off 100 basis points from its margin.
• TNEB accounts for almost half of its revenues, making it over-dependant on it.

Valuation

EPS for the FY 2005 is Rs 7.3 on post-issue equity. At an offer price of Rs 130, PE works out to 17.8. Annualised half-year EPS is Rs 9.2 and PE 14.1. TTM PE for the power sector is around 20.

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Disclosure: Hold positions