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Union Bank: Other income bears fruit - Views on News from Equitymaster
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Union Bank: Other income bears fruit
May 7, 2008

Performance summary
  • Interest income grows by 28% YoY in FY08; 24% YoY in 4QFY08.
  • Other income grows by a whopping 58% YoY in FY08.

  • Net interest margins sustained drops from 3.1% in FY07 to 2.8% in FY08.

  • Capital adequacy ratio at 12.5% at the end of FY08.

  • Net NPA ratio improves from 0.6% in FY07 to 0.2% in FY08.

  • Proposes dividend of Rs 4 per share (dividend yield 2.3%).

Rs (m) 4QFY07 4QFY08 Change FY07 FY08 Change
Interest income 20,949 26,024 24.2% 73,822 94,473 28.0%
Interest Expense 12,526 17,685 41.2% 45,920 63,610 38.5%
Net Interest Income 8,423 8,339 -1.0% 27,902 30,863 10.6%
NIM (%) 3.1% 2.8%
Other Income 2,418 3,107 28.5% 6,865 10,870 58.3%
Other Expense 3,259 2,539 -22.1% 14,759 15,930 7.9%
Provisions and contingencies 3,153 3,652 15.8% 6,204 7,289 17.5%
Profit before tax 4,429 5,255 18.6% 13,804 18,514 34.1%
Tax 2,144 44 -97.9% 5,350 4,644 -13.2%
Profit after tax / (loss) 2,285 5,211 128.1% 8,454 13,870 64.1%
Net profit margin (%) 10.9% 20.0% 11.5% 14.7%
No. of shares (m) 505.1 505.1
Book value per share (Rs)* 111.3
P/BV (x) 1.6
* (Book value as on 31st March 2008)

What has driven performance in FY08?
  • Advances – Nothing enthusing: Although not overriding the growth of its peers, Union Bank of India (UBI) managed to hedge the slowdown in the growth of retail and agriculture segments with the help of its reach in the Tier II cities, by tapping the SME clients. On the back of 17.5% YoY growth in retail credit (20% of total advances), 38.6% growth in SME segment and 20% YoY growth in its corporate loan portfolio, UBI registered a 20.5% YoY growth in advances in FY08, marginally under-performing the sector average. However, the lack of pricing power in advances has taken a toll on the bank’s NIMs that have fallen by 30 basis points (0.3%) in the last fiscal. The bank has also set a target of enhancing its CASA proportion by 2% annually and is targeting NIM of 2.8% for FY09 as well.

    Trailing the sector…
    FY07 % of total FY08 % of total Change
    Advances 330,010 397,810 20.5%
    Corporate 67,580 20.5% 81,110 20.4% 20.0%
    Agriculture 106,390 32.2% 114,720 28.8% 7.8%
    Retail 67,710 20.5% 79,560 20.0% 17.5%
    SME 88,330 26.8% 122,420 30.8% 38.6%
               
    Deposits 851,800 1,038,590 21.9%
    CASA 293,860 34.5% 362,040 34.9% 23.2%
    Term deposits 557,940 65.5% 676,550 65.1% 21.3%

  • Costs advantage: The bank’s cost to income ratio dropped from 42% in FY07 to 38% in FY08. This because of the natural attrition of some of its employees. Further, in the next 3 to 4 years, around 4,000 employees of the bank will be retiring, thus considerably lightening its wage burden. Also, the bank has proactively fully provided for its AS15 requirement of Rs 3.5 bn in FY08 itself. Thus, it is unlikely to see any negative or one time cost surprises in the medium term. We expect this cost advantage to further improve the bank’s efficiency ratios. The bank expects its cost to income ratio to stabilise at 41% by FY10 (one of the lowest in the banking sector).

  • Fees – Yet to gather steam: UBI has a lot of catching up to do with its peers in fee income, which has barely grown by 9.9% YoY in FY09. The growth in other income in FY09 can largely be attributed to profit on sale of investments that have grown 166% YoY. After remaining stagnant at 7% of total income for four fiscals, UBI’s fee income has improved to 8.8% of total income in FY08.

  • Delinquencies not a worry: While UBI has witnessed a 12% YoY reduction in the absolute value of its gross NPAs over the last 12 months, the net NPAs too have declined from 0.6% of total advances in FY07 to 0.2% in FY08. More importantly, the cash recoveries to the tune of Rs 6.4 bn substantially reduced the provisioning requirement for the bank in 9mFY08.

What to expect?
At the current price of Rs 174, the stock is valued at 1.0 time our estimated FY10 adjusted book value. UBI’s capital adequacy ratio was at 12.5% at the end of March 2008. While the bank is currently comfortably placed in terms of capital adequacy and has sufficient room for perpetual debt and Tier II bonds to grow its business and for Basel II compliance, it may have to opt for dilution (rights issue) in the medium term. If the bank wishes to accelerate its advance growth or opts for inorganic growth, capital dilution will be necessary and the same will temporarily dilute shareholder returns.

Adequate capital, a high provisioning cover and reasonable consistency in asset quality makes it a de-risked play in the PSU banking space. We retain our view on the stock.

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