Bank of India: Buy

Investors with a higher than normal risk appetite can consider buying the Bank of India (BoI) share at current market price of Rs 250.

Returns from this point, however, could be muted in line with the trends seen in peers such as Bank of Baroda, Canara Bank, Corporation Bank, Oriental Bank of Commerce and Union Bank of India in the past two years.

In this group, banks such as Corporation Bank have posted decent earnings growth, while some such as Union Bank of India and Bank of Baroda have posted more sedate growth.

These banks are broadly trading around 10 times their recent earnings and have been trading in this valuation range since September/October 2005.

The Bank of India stock is now trading at a similar valuation (about 10 times its FY 07 earnings), having seen a downward move from a multiple of 18-20 times two years ago. A downward move to the valuation zone of the other public sector banks seems to have occurred and the risk is of this becoming permanent.

In the event, returns from an investment in this stock may not match what has been recorded in the past few years.

The Bank of India stock has returned around 57 per cent in the last one year and has also provided fairly high returns (of 45-50 per cent per annum) over a three-to-five-year period. This places the BoI stock in the company of other counterparts such as Axis Bank, State Bank or HDFC Bank, which have generated similar returns. In contrast, Canara, Bank of Baroda and Oriental Bank of Commerce have generated returns of 13, 11 and 15 per cent, respectively, in the past one year.

There also appears to be a valuation fatigue with respect to the public sector banks listed above. This valuation drag could be on account of the relative performance of the public sector banks vis-À-vis the new private sector banks as well as due to the fact that FII holdings in most of these banks are close to or at the permissible limit of 20 per cent. FII holding in BoI is currently around 16.50 per cent and any move by them to increase this may see valuations rising.

Underlying performance

From a fundamental perspective also, BoI’s business performance is not such as to place it differently from its public sector peers. Growth in certain key parameters that drive earnings and returns on equity — such as advances, deposits, interest income, interest expenditure, other income, operating expenses — has broadly moved in line with the peer group.

In the past five years, Bank of India’s advances portfolio has grown at a CAGR (compounded annual growth rate) of 18 per cent, which is slightly lower than the 22-23 per cent growth posted by its nearest peers Canara Bank and Bank of Baroda. In comparison, Axis Bank and HDFC Bank have grown their advances by around 50 per cent CAGR in the past five years.

BoI has been able to grow its deposit base at around 15 per cent, which is again slightly lower than the 17 per cent growth of Canara and Bank of Baroda and much lower than the 30 and 35 per cent growth of HDFC Bank and Axis Bank.

At around 41 per cent, BoI’s share of low-cost deposits is quite high by industry standards as well as its peer group. But interest expenditure growth at 9 per cent in the past five years is broadly in line with peer banks’ levels and, in fact, is higher than that of Bank of Baroda, which has seen a 6 per cent rise in interest expenses.

In comparison, interest expenditure for both Axis Bank and HDFC Bank has grown by 25 per cent in the past five years.

Scoring over peers in non-interest income

One parameter on which BoI scores well over its peer group is in respect of non-interest income. Non-interest income has grown by close to 8 per cent on average in the past five years, which places BoI alongside State Bank of India . Against that, other income for Canara Bank, Bank of Baroda and Punjab National Bank have all grown by only 1.5-2 per cent in the last five years. The private sector banks — Axis and HDFC Bank — though, have grown their non-interest income by as much as 20 and 35 per cent respectively, in the past five years.

Missed opportunities and prospects

The overall message from the above business numbers and growth performance of BoI (other public sector banks as well) vis-À-vis that of private sector banks is one of missed opportunities in an economy that has registered strong growth in the past few years. It is difficult to see a radical and, more importantly, a quick shift in the business strategies of the public sector banks that may enable them to capitalise fully on the still strong growth impulses in the economy.

But, their established presence, network and the relationships built over almost a century of banking are their main strengths that could provide a certain measure of stability to the earnings stream and could even stand them in good stead in a business/economic downturn.

Corporate lending and relationships, in which public sector banks have relatively more focus, could help them maintain the income flow as against retail lending where relationships are not a material factor. The quality/income potential of the retail portfolio would, therefore, be more subject to system-wide influences.

Overall, investments in stocks such as BoI could provide decent long-term investment returns in the mid- to high teens.