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BOI: Should you subscribe?

Mar 22, 2005

'Assessing quality of assets is imperative for valuing a banking entity', may be a statement sounding clichéd. But when speculations of prospective mergers and public issue announcements cause investors to go gung-ho on the banking sector, it becomes important to reinstate these basic doctrines of investing.Bank of India, the sixth largest bank in the country, both in terms of market share (5.3%) and asset size, has been riding high on speculations of merger with Union Bank of India. The announcement of its second public issue envisaged during 1HFY06 only fuelled the 'optimism' further.

The bank has witnessed a reasonable growth in its advance book during 9mFY05, particularly during the second and third quarters. At the end of 9mFY05, retail and corporate credit (of the non food credit segment) accounted for 22% and 68% of the loan book respectively. Food credit growth on the other hand, dampened on the back of higher allocation to non-food credit and accounted for only 10% of the total disbursements.

In recent times…
Despite garnering a larger share of low cost deposits (40%) in an attempt to prune its cost of funds, lowering yields on advances and investments have caused the bank's net interest margins to slide further. What spells concern is that the healthy growth in advance book has also failed to compensate for the shrinking margins. Going forward, inability to improvise on this situation may imply more pressure on the bank's operating margins.

Despite having transferred G-Secs of Rs 3.8 bn to the 'held to maturity' category in 2QFY05, the bank has booked treasury losses to the tune of Rs 1.5 bn in 3QFY05. In the rising interest rate scenario, treasury operations are unlikely to yield the bank any gains in the coming quarters. The bank's other income (which tanked by 36% YoY in 9mFY05) has caused its annualised FY05E EPS to condense further, thereby aggravating the P/E valuations for the current fiscal (FY05).

Lower margins or timid growth rates are never as much of a concern as is asset quality. In case of BOI, its net NPA to advances figure (3.9%), which puts it at the bottom of the larger banks' league in terms of asset quality, negates all potential upsides. Although the quantum of loss assets have been successfully reduced from 5.5% in 1HFY04, the possibility of the same declining further remains questionable in the event of no treasury gains.

What to expect?
At the current market price of Rs 116, the stock is trading 1.4 times its 9mFY05 book value.

BOI is envisaging its second public issue of 125 m shares by 1QFY06. Assuming that the shares get valued at the current market price and get fully subscribed, the issue will infuse additional capital to the tune of Rs 14.5 bn to the bank's networth.

Valuations Post 2nd public issue
FY05EFY06EFY07E
Price to Earnings (x)13.610.511.4
Price to adj. Book value (x)2.51.9 1.6

Although this brings the book value per share to Rs 111 in FY07, the net NPA per share of Rs 41 brings the adjusted book value per share to Rs 70. We can thus comprehend that the forward price to adjusted book value (P/Adj.BV) valuations remain overstated for the stock despite accretion to book value. With better and more visible stories available in banking and other sectors, we see no reason for investors to compromise on their 'investment quality'.


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