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SBI: Dwindling prospects?
Oct 27, 2005

Performance summary:
SBI, after the stellar act over the past few quarters, has registered a slightly subdued performance for the quarter ended September 2005. The bank, despite remaining consistent in terms of topline growth, has shown signs of significant slowdown in net interest income. At the same time, the bottomline growth of 12% YoY (consolidated profits up 11% YoY) is largely in tune with the trend over the past few quarters. While there has been a considerable fall in other income, the same was partially compensated by the lower tax incidence. We also attended the analyst meet and our result analysis includes extracts from the same.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 80,848 85,614 5.9% 157,514 177,276 12.5%
Other Income 16,526 12,946 -21.7% 31,913 28,712 -10.0%
Interest Expense 47,050 49,535 5.3% 94,175 98,665 4.8%
Net Interest Income 33,798 36,079 6.7% 63,339 78,611 24.1%
Net interest margin (%)       3.2% 3.4%  
Other Expense 24,275 29,197 20.3% 48,488 53,100 9.5%
Provisions and contingencies 7,574 8,175 7.9% 10,861 25,840 137.9%
Profit before tax 18,475 11,653 -36.9% 35,903 28,383 -20.9%
Tax 7,657 (500)   14,500 4,000 -72.4%
Profit after tax/ (loss) 10,818 12,153 12.3% 21,403 24,383 13.9%
Net profit margin (%) 12.6% 15.0%   13.6% 13.8%  
No. of shares (m) 526.3 526.3   526.3 526.3  
Diluted earnings per share (Rs)* 82.2 92.4   81.3 92.7  
P/E (x)         9.0  
* (annualised)            

The country’s largest banking entity
SBI is India's largest financial entity with an asset size of over Rs 4 trillion. Although the bank's loan book is largely skewed towards corporate (63% of non-food advances), the retail side is also fast catching up. The bank has been a major beneficiary of the current upturn in investment cycle and has continued to witness a substantial growth in both retail and corporate segments. It is also an active trader in forex and is the leader in cash management services. SBI has a network of over 9,000 branches and 5,000 ATMs across the country.

What has driven performance in 2QFY06?
NII meltdown: SBI continued to play the volume game by registering 31% growth in advances for 2QFY06. The same is commendable in the light of the fact that the growth is being achieved on an advance base of more than Rs 202 bn. To put things in perspective, SBI is adding advances equal to that of HDFC Bank every half year. The bank continues to emphasise on its retail portfolio (25% of credit book) that grew by 36% YoY, although it has adopted a cautious stance on the home loan segment (54% of retail portfolio). The bank witnessed an expansion in its net interest margins by 20 basis points that can be accredited to fall in cost of IMDs. However, the same does not seem to be reflecting on the net interest income that witnessed single digit growth after several quarters. While the average yield on advances remained flat over that at the end of 1HFY05, repricing on the bond portfolio (yield on advances) reduced the bank’s interest income. On the funding (liabilities) side, although the bank anticipates the IMD redemption (due in December 2005) to have a benign impact on the average cost of deposits, it also acknowledged that the declining trend in funding cost is set to reverse in the medium term.

CD ratio strengthening…
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Advances 1,817,210   2,383,510   31.2%
Retail 434,313 23.9% 588,727 24.7% 35.6%
Corporate 1,382,897 76.1% 1,794,783 75.3% 29.8%
Deposits 3,376,840   3,800,520   12.5%
Credit deposit ratio 53.8%   62.7%    

Commissions dent fee: The change in the computation of commission on government business (from value to volume based) has not hit any other bank as hard as SBI. The bank despite growing its government business volumes by 20% in 1HFY06 saw commissions from the same fall by 20% YoY. Fall in profit on sale of investment (2QFY06 profits are 50% of 2QFY05 profits) also added to the other income woes. Since the bank continues to have a considerable proportion of GSecs in the AFS basket (available for sale - approximately 55%), risks on the treasury side cannot be sidelined.

People problem: The bank witnessed 9% YoY growth in its staff cost (69% of total operating cost) due to wage revision. The cost to income ratio thus, has stagnated at 50% (one of the highest in the sector). While the bank does not see the same reducing going forward (as there are no VRS plans on the anvil), it hopes to derive the benefits of ‘employee-repositioning’ in the longer term.

NPAs-awaiting Dabhol windfall: Although the net NPAs of the bank have reduced in percentage terms (from 2.9% in 2QFY05 to 2.3% in 2QFY06), there has been no success in paring the same in absolute terms. This is because the recoveries have been replaced by additional slippages. However, once the bank gets the approval to treat the stressed ‘Dabhol assets’ as standard assets (which is likely sometime later in FY06 or FY07), it may see the net NPAs come down to 1.8% of advances.

What to expect?
During 1QFY06, SBI acquired 51% equity in Indian Ocean International Bank Limited (IOIB), Mauritius. This was followed by acquisition of 76% stake in Giro Commercial Bank (Kenyan bank) in 2QFY06, which has an asset base of US$ 60 m. The bank will continue to pursue the inorganic growth route in the overseas markets (international business stood at US$ 7 m in 1HFY06) and is envisaging additional borrowing for the same. This also seems inevitable given the fact that that SBI does not have sufficient capital to aid its growth (CAR 11.3% in 2QFY06) and with the redemption of IMDs (India Millennium Deposits) in FY06 is going to face severe funding constraints. The benefits of tax refund that the bank has been reaping over the past few quarters are also not sustainable in the longer term and this will have a ‘visible’ impact on the bank’s profitability going forward.

At the current price of Rs 823, the stock is trading 1.3 times our estimated FY08 adjusted book value. We had given a ‘hold’ on the stock in April 2005. Although we believe that the stock is fairly priced on a standalone basis, the value of the consolidated entity (which will unlock once the associate banks are merged with it in the next 1 or 2 years) offers substantial upside. We therefore reiterate our view.

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