Pick of the week
Indian Overseas Bank (INDOVE)
By Chirag J Shah
Company Background
Indian Overseas Bank (IOB) is a mid-sized public sector bank headquartered in Chennai. The bank has a dominant presence in southern India, which accounts for 45% of its branch network. At present, the bank has a network of 1,781 branches spread across the country. IOB has a strong international presence in eight countries. The bank is characterised as one having superior NIMs, best return ratios - return on equity (RoE) - and healthy asset quality. IOB did business of Rs 115,800 crore and had a balance sheet size of Rs 82,256 crore in FY07. On the technology front, 72% of business, or 800 branches, are covered under core banking solutions (CBS). The bank plans to enhance this number to 90%, or 1,500 branches, by FY08. Also, IOB plans to foray into a joint venture with Sompo Japan Insurance Inc, Allahabad Bank, Karnataka Bank and Dabur Investment for starting its non-life insurance business.
Investment rationale
Business to grow at 20% coupled with reasonable NIMs
The total business grew by 21% to Rs 148,420 crore. The main contributions were from a 30% surge in advances from Rs 48,610 crore in Q1FY08 to Rs 63,419 crore in Q1FY09 and a 21% jump in deposits from Rs 70,205 crore in Q1FY08 to Rs 85,001 crore in Q1FY09. We expect advances to grow at 21% and deposits at 15% CAGR over FY08-FY10E. IOB's growth strategy hovers around strong growth in advances to the industrial sector, SME sector and the retail side, thereby enabling it to realise better yield on advances. However, due to the recent deposits rate hikes, the pressure on margins will increase. Still, we believe that with a reasonable CASA ratio of 32% over FY08-FY10E, the bank will be able to maintain its margins around 3% levels. We expect the NII to grow at a CAGR of 15% over FY08-FY10E.
Fall in bond yields to augur well for the investment book
The steep rise in the G-sec yields at 9% levels has caused a lot of banks, especially the PSBs to make provisions in the AFS category in their investment portfolio. This had its impact on the stock prices of PSBs like IOB. However, now, as yields have fallen, the MTM losses will revert to MTM gains. This will add to the bottomline of the company. Also, IOB has lowered the duration of its investment book from four years to two years. Further, IOB has de-risked its investment book by paring down its AFS portfolio from 26.5% in Q4FY08 to 25% in Q1FY09. During Q1FY09, IOB incurred a Rs 170-crore loss on reclassification of investments from AFS to the HTM category and a Rs 50 crore loss on equity trading.
Enjoys high RoEs among its peers:
IOB commands the best return on equity (RoE) in the Indian banking space. The bank registered an RoE of 28.1% in FY07 and 27% in FY08. The bank is gearing its capital almost 19-20 times, thereby producing super normal RoEs. Though we believe the bank would require this in order to maintain higher RoEs, the failure to do so put pressure on their RoEs. Recently, IOB raised capital in the form of bond issue worth Rs 700 crore. We believe this will allow IOB to maintain RoEs of 23%-24%.
Risks
a.. Rising interest rates impacting cost of funds
With interest rates rising, cost of funds is going up continuously putting pressure on NIMs also. If monetary tightening with high inflation continues for a longer period, we may see margins declining further and a credit slowdown, which can impact future profitability.
a.. Asset quality may be impacted if higher rates persist for longer tenure
Quarter ended Year ended Rs. cr
year 2008/06 2007/06 var % 2008/03 2007/03 var %
Sales Income 2,217.08 1,846.21 20.09 7,968.25 5,832.07 36.63
Other Income -30.25 61.58 -149.12 807.62 387.05 108.66
Expenditure 394.20 423.44 -6.91 1,832.14 1,574.41 16.37
Interest 1,490.91 1,137.20 31.10 5,288.79 3,271.27 61.67
Gross Profit 241.19 409.17 -41.05 2,001.78 1,560.04 28.32
Depreciation 0.00 0.00 0.00 0.00 0.00 0.00
Tax 45.75 78.66 -41.84 452.60 365.00 24.00
PAT 255.97 268.49 -4.66 1,202.34 1,008.44 19.23
Equity 544.80 544.80 0.00 544.80 544.80 0.00
OPM (%) 82.22 77.06 5.16 77.01 73.00 4.01
GPM (%) 14.97 15.47 -0.50 10.63 16.91 -6.28
NPM (%) 11.54 14.54 -3.00 15.08 17.29 -2.21
Key Financial Ratios
2007/03 2006/03 2005/03 2004/03 2003/03
EPS 18.51 14.38 11.96 9.41 9.35
CEPS 19.63 15.39 12.81 10.14 10.26
Book Value 87.05 71.08 56.08 44.67 35.43
Dividend/Share 3.00 2.60 2.40 2.00 1.60
OPM 20.83 20.33 22.07 18.15 12.58
RONW 25.97 24.21 26.53 26.47 28.41
Debt/Equity 17.75 16.54 18.18 21.49 25.14
Ratio 0.26 0.30 0.34 0.39 0.46
Interest Cover 1.43 1.44 1.51 1.39 1.23
Financials:
Total deposits grew from Rs 70,205 crore in Q1FY08 to Rs 85,001 crore in Q1FY09 recording a jump of 21.08%. Gross advances increased from Rs 48610 crore as on Q1FY08 to Rs 63419 crore in Q1FY09, growing by 30.46%. The operating profit for Q1FY09 was at Rs 241.18 crore as against the operating profit of Rs 409.17 crore for Q1FY08. This decrease in the first quarter of this year was mainly due to the loss booked on account of the inter segment category transfer of securities and loss on sale of securities and provision for wage arrears.
The net profit for Q1FY09 was Rs 255.97 crore. This figure was lower by Rs.12.52 crore when compared to the net profit of Rs 268.49 crore booked during Q1FY08. Business per employee increased from Rs 4.81 crore in Q1FY08 to Rs 5.93 crore in Q1FY09. The gross NPA came down from 2.34% in Q1FY08 to 1.73% in Q1FY09. However, the net NPA percentage has gone up from 0.50% to 0.75% for the same period. We expect IOB to deliver a 15% CAGR in PAT over FY08-FY10E.
technical analysis
Valuations
At the current market price of Rs 101, the stock is trading at 1.1x and 0.9x its FY09E and FY10E ABV of Rs 92 and Rs 114, respectively. We believe IOB at these levels offers value in terms of reasonable business growth coupled with higher than average NIMs. We believe the bank will be able to generate higher than average RoEs of 23-24%. We expect the company to deliver a 20% return over six months. At the target price of Rs 121, the stock is trading at 1.3x and 1.1x its FY09E and FY10E ABV.
Technical outlook
The stock has recovered sharply from the low of 69. It looks attractive on the chart. It is rising with high volumes indicating bullishness. This also shows that an uptrend is building. The stock is forming a bullish pattern of higher top and higher bottom in the daily chat. If it crosses the level of 104, this will give an ascending triangle break out on the higher side.
The stock came under pressure due to profit-booking during January and May 2008. This is in line with the market as a whole. The stock is currently trading above the 50 days simple moving average. Among oscillators, the RSI is rising above the oversold territory. It is currently at 44 levels and looks strong for more up side. The immediate support comes around 92 levels. One can expect a target around 120 levels.
Experience is the teacher of all things.
- Julius Caesar
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