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Bank of Baroda: Global prospects - Views on News from Equitymaster
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Bank of Baroda: Global prospects
Feb 27, 2007

Performance summary
Bank of Baroda recently announced results for the third quarter and nine months ended December 2006. Although the bank’s incremental asset growth numbers have shown modest expansion this quarter, the same has been relatively muted as compared to that clocked over the past few quarters. Despite the strong traction in fund-based revenues, the bank has faced pressure on its net interest margins (NIMs). The bank’s other income, however, has helped substitute much of the margin loss. A higher tax incidence has capped the profits emanating from curtailment in operating overheads.

Rs (m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Income from operations 17,732 23,870 34.6% 50,949 65,405 28.4%
Other Income 2,743 3,336 21.6% 8,383 9,329 11.3%
Interest Expense 9,599 14,262 48.6% 27,867 38,591 38.5%
Net Interest Income 8,133 9,608 18.1% 23,082 26,814 16.2%
NIM (%)       3.3% 3.2%  
Other Expense 5,784 6,375 10.2% 16,351 17,859 9.2%
Provisions and contingencies 2,250 1,417 -37.0% 6,591 6,064 -8.0%
Profit before tax 2,842 5,152 81.3% 8,523 12,220 43.4%
Tax 820 1,860 126.8% 2,340 4,412 88.5%
Profit after tax/ (loss) 2,022 3,292 62.8% 6,183 7,808 26.3%
Net profit margin (%) 8.5% 18.6%   9.5% 15.3%  
No. of shares (m)       293.2 364.3  
Diluted earnings per share (Rs)*       28.1 28.6  
P/E (x)         7.7  
* (12 months trailing)

A de-risked play
Bank of Baroda is the fifth largest banking entity in the country (in terms of asset size) with 4% share of the total credit disbursals at the end of FY06. Given its geographic concentration in the northern regions, the bank was a laggard in terms of credit growth in the initial years of this decade, which resulted in a loss of market share (from 5.7% in FY02 to 4% in FY06). However, a brand and operating overhaul led to accelerated growth in the last two fiscals, thus helping it stabilise its share and position itself favourably amongst its peers. Adequate capital (CAR 12.2% in 9mFY07), high NPA coverage and hedge against interest rate risks peg the bank amongst the frontrunners in the public sector banking space.

What has driven performance in 3QFY07?
Foreign shores beckon: In line with its past performance, Bank of Baroda continued to outdo its peers in public sector banking space in terms of asset growth. The bank’s global portfolio continues to incrementally contribute higher to its asset book and the bank had 11% of its business exposure (deposits and advances) overseas at the end of 9mFY07. In terms of profitability, the international operations had contributed 28% of the bank's profits at the end of FY06. While the bank’s global advances grew by 47% YoY, the global deposits grew by 39% YoY.

  9mFY06 % of total 9mFY07 % of total Change
Advances 528,940   711,904   34.6%
Global 52,894 10.0% 77,661 10.9% 46.8%
Domestic 476,046 90.0% 634,243 89.1% 33.2%
Deposits 857,060   1,187,686   38.6%
Global 85,706 10.0% 112,298 9.5% 31.0%
Domestic 771,354 90.0% 1,075,388 90.5% 39.4%

The hike in interest rates in the domestic markets coupled with the shortage of liquidity led to a slower advance growth in the domestic markets. However, on the back of 49% YoY growth in retail credit (20% of total domestic advances) and 52% YoY growth in farm credit, Bank of Baroda registered a 33% YoY growth in domestic advances in 9mFY07, outperforming the sector average of 29% YoY. Having said that, given that the bank’s deposit growth in the domestic market is not commensurate with its advance growth, the pressure on margins is inevitable in a rising interest rate scenario. While the NIMs for 9mFY07 stand at 3.2%, we have estimated lower NIMs for the full year.

Other income – Signs of visibility: Bank of Baroda's recent initiatives for improving its non fund based income resource seem to have started yielding results this quarter. It may be recalled that the bank had entered into an MOU with IDFC for funding the projects appraised by it. This is expected to ensure good quality lending and big-ticket loans but also fetch the bank proportionate fee income. While the bank’s fee income had been stagnant over the past few quarters, the same has registered an appreciable 22% YoY growth in this quarter. However, as a proportion of total income, other income has infact reduced from 27% in FY02 to 26% in 9mFY07. Although, the investment book of the bank is not a concern, diminishing fee income will endanger the sustainability of net margins, as the core banking business gets commoditised and more competitive private sector and foreign players cannibalise on its market share.

Costs to even out: The bank has pared its cost to income ratio from 52% in 9mFY06 to 49% in 9mFY07. Also, only 40% of Bank of Baroda's employees (38,774 at the end of FY06) have opted for the pension scheme, which otherwise would have burnt a hole in the bank's reserves as in the case of most other PSU banks. The bank has also clarified that it has been providing for pension related expenses on actuarial basis, thus taking care of future liabilities in its books. Further, in the next 3 to 4 years, around 4,000 employees of the bank will be retiring, thus considerably lightening its wage burden (as most of these employees are in the high salary bracket). For filling the requisite vacancies, the bank will be recruiting around 300 people each year for the next 3 to 4 years, at relatively lower salary levels as compared to the retirees. We expect this to rationalise the bank's overheads and bring down its cost to income ratio at par with that of its peers in the sector.

Delinquencies tapering: While the bank has witnessed a 21% reduction in the absolute value of its gross NPAs (3% of total advances), even at the net NPA level the higher provisioning has brought down the same from 1.1% of advances in 9mFY06 to 0.7% in this quarter. Despite the high gross NPAs, the lower incremental delinquencies, higher recoveries and an adequate coverage ratio of 78% for NPAs, dilute concerns on the delinquency front.

What to expect?
At the current price of Rs 220, the stock is very attractively valued, trading at 0.9 times our estimated FY09 adjusted book value. After maneuvering its 'image-rebuilding' exercise since FY05, Bank of Baroda has repositioned itself as a lead competitor to the players not only in the PSU but also in the private sector banking space. Adequate capital, a high provisioning cover, exposure in overseas markets and reasonable consistency in net interest margins makes it a de-risked play in the PSU banking sector. The interest rate risk due to excessive dependence on fund-based revenues is the only downside to the prospects of the bank. We had recommended a ‘BUY’ on the bank with a FY09 target price of Rs 360. We stand by our recommendation.

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