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BOB: Not enthusing

Aug 20, 2004

Introduction to results
Bank of Baroda (BOB) had recently reported a strong financial performance for 1QFY05 on the back of profits from its G-Sec investments. BoB posted a strong 20% bottomline growth, while its topline fell marginally due to falling yields. Due to strong rise in operating expenses operating margins have however come under pressure. While the company has reported encouraging results for the June quarter, the bank's high reliance on other income is a cause of concern.

(Rs m) 1QFY04 1QFY05 Change
Income from Operations 15,869 15,284 -3.7%
Other Income 2,101 3,946 87.8%
Interest Expenses 9,224 8,454 -8.4%
Net interest income 6,645 6,830 2.8%
Other Expenses 4,096 4,811 17.5%
Operating Profit 2,548 2,019 -20.8%
Operating Profit Margin (%) 16.1% 13.2%  
Provisions and Contingencies 1,014 1,622 59.8%
Profit before Tax 3,635 4,343 19.5%
Tax 1,190 1,414 18.8%
Profit after Tax/(Loss) 2,445 2,930 19.8%
Net Profit Margin (%) 15.4% 19.2%  
No. of Shares (m) 294.3 294.3  
Diluted Earnings per share (Rs) 33.2 39.8  
P/E Ratio (x)   3.9  

What is the company's business?
BOB is one of the oldest the largest public sector banks in the country with a pan India presence, with over 60% of its branches in the rural and the semi-urban region. While the bank is one of the largest banks in the country its growth in the recent past has been lackluster with its advances growing by a CAGR of 13% over the last three years. The bank is currently in the process of implementing a core banking system for its bank, as well as integration of all its branch networks.

What has driven the performance in 1QFY05?
Sales:  While at the first glance the numbers look enthusing, the bank's lending growth has not shown any significant improvement. The pressure on the bank's core business of lending is not a good sign. Advances growth of BOB in 1QFY05 was 13%. Very high competition is also taking a toll on the core lending operations of the bank. While its retail advances have grown strongly by 57%, like other banks, wholesale lending has suffered, due to lack of credit offtake as well as strong competition. Despite its size BOB (one of the largest public sector banks in the country) has not been able to grow its advances on a commensurate scale. Infact in FY04, the bank had reported a below industry growth rate in its core advances. The yield on advances have fallen and this has led to the fall in topline.

Falling interest rates have however helped BOB to mitigate the effect of poor topline growth. Due to lower interest expenses, the bank has seen a marginal improvement in its net interest income. Net interest margin (NIM) has also improved to 3.2% in 1QFY05 compared to 3% in 1QFY04. As we had pointed out earlier, due to a soft interest rate scenario, further improvement in NIM may be an uphill task and it may even stagnate at this level. We observe that compared to FY04, where the bank had a NIM of 3.3%, it has dropped to 3.2% in 1QFY05, indicating that fall in interest rates may have bottomed out.

Operating margins:  BOB has witnessed a fall in its operating margins for the June quarter, this is mainly on account of the marginal improvement in net interest income as well as strong growth in operating expenses. The bank is engaged in the implementation of a core banking system and also large scale technology implementation and this is likely to have led to the strong rise in operating expenses. Cost to income ratio has fallen to 45% compared to 47% in 1QFY04. While this is a good trend, the fall is primarily on account of higher other income and less so due to improvement in operating efficiency.

Net profits:  BOB, continues to book profits from sale of investments in G-Secs and this has had a very large contribution towards the bank's bottomline improvement. Profits from sale of investments constituted around 56% of the total other income in 1QFY05 compared to 32% in 1QFY04. The very high dependence of other income on profit on sale of investments indicates the lack of quality of the profitability. Now as interest rates are slowly on the rise these gains are slowly getting wiped off and the bank has been forced to provide for these losses. Hence of one were to look at the provisioning made by the bank on the June quarter, we see that while the provisioning has risen, most of it is due to the significant rise in provisioning for depreciation in the bank's G-Sec investments. BOB has been able to bring down its NPAs further to 2.9% compared to 3.8% in the same period last year.

What to expect?
The stock at Rs 155 is trading at an adjusted price to book ratio of 2x its 1QFY05 book value. The bank continues to fare poorly on a relative basis as far as its core business of lending is concerned. The only consolation is that it has been able to improve its asset quality, however the pace of the same has slowed down in the last two quarters. Net NPA to advances ratio is still high compared to some of its peers. We believe that most of the good news has already been factored in BOB and the bank will have to significantly improve core business growth to find favour among investors.

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