Bank of Baroda

Investors with a two-year investment horizon can consider fresh exposure to the stock of Bank of Baroda. The bank may continue to grow at higher-than-industry average rate (on the loan book front) and post strong profit growth in relation to most of its peers going forward.



The bank has strong presence in India and is among the banks with high overseas contributions (24 per cent of total business from foreign branches), helping it to diversify revenues geographically.

Strong profitability ratio (return on net worth of 22 per cent), adequately capitalised loan book with low proportion of non-performing assets (NPA), falling costs and improving core and fee-income sources have also resulted in declining cost-income ratios.

Yet, the domestic cost-income ratio is 47.1 per cent for the year ended March 2010 and offers scope for further improvement.

At the current market price of Rs 717, the stock trades at an estimated FY11 consolidated price-to-adjusted book value(P/ABV) of 1.65 times and consolidated FY-11 price-to-earnings ratio (P/E) of seven times. The book value is adjusted for net NPAs and revaluation reserve.

In terms of P/ABV, it trades at a discount to SBI and Punjab National Bank. While the stock may appear to be fairly valued at this juncture, upside from hereon would have to come from superior business growth. Given that the stock has gained 44 per cent year-to-date on re-rating, investors can consider accumulating the stock on dips.

Sustained credit growth

As of March 31, 2010, global advances grew at 22 per cent with domestic loan book growing at 21 per cent — almost 5 percentage points higher than the total loan growth rate of banking industry.

The loan book grew at 30 per cent compounded annually during the period 2006-10, higher than the industry average. With the RBI projecting a 20 per cent net bank credit growth, Bank of Baroda loan book could well expand at a higher rate, given that it has historically exceeded industry average.

While loan book growth typically tends to decline in the first quarter, however, this time around, the system-wide credit grew by 20 per cent thanks to credit demand on account of 3G and BWA auctions.

With other sectors yet to tap the market, the credit growth may surpass RBI projections. Bank of Baroda is adequately capitalised for taking advantage of this growth opportunity. The current capital adequacy is 14.36 per cent with Tier-1 capital ratio of 9 per cent. The bank's loan book can grow at 25 per cent over the next two years and yet maintain capital adequacy.

Margins

In FY-10, despite strong growth rate in advances, the credit-deposit ratio of the bank declined to 72 per cent. The fall was due to higher growth in deposits. However, the deposit growth was primarily from low-cost deposits (CASA). With improving global CASA base, the cost of funds can be contained.

The bank's net interest margin fell to 2.74 per cent from 2.91 per cent, as a result of fall in overseas banking margins. Domestic NIMs though stood at 3.12 per cent and has been steadily improving from the first quarter of FY10. The cost of funds is set to rise from the current quarter, given the new savings bank interest computation and the repo rate hike.

Pressure in the form of CRR hike and savings bank interest will be mitigated by strong credit growth, improving CASA proportion and improved credit-deposit ratio in the current fiscal.

Thus, despite pressures, NIMs can hold above 3 per cent even as overseas margins may improve with recovery in key markets such as the UK and West Asian countries. The base rate of 8 per cent wouldn't alter the yields on advances for the bank as the management is reported to have indicated that only 2-3 per cent of their current lending is below this rate. In addition, overseas loan book which form 24.7 per cent of the total book doesn't come under the base rate purview.

Strong profitability

The bank's net profit grew at 38.7 per cent compounded annually between FY-06 and FY-10. With strong branch network expansion expected this year, the fee income and CASA ratio may improve going forward. The bank has also become 100 per cent CBS-enabled in the last one year, further increasing the scope for fee income.

The above growth may nevertheless moderate due to increased operating expenses such as wage costs due to recruitments and branch expansion (400 branches expected to be added).

Asset quality

The gross NPA ratio increased slightly to 1.36 per cent as of March 2010, still lower than most public sector banks. Around 25 per cent of the fresh slippages into NPA were due to restructured assets. Slippages and restructuring predominantly seen in agricultural portfolio, may now see some upgrade with a normal monsoon.