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Bank of Baroda: Racing ahead - Views on News from Equitymaster

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Bank of Baroda: Racing ahead

Oct 30, 2006

Performance summary
Bank of Baroda announced results for the second quarter and half year ended September 2006. Being amongst the few public sector banks to outperform the industry average in terms of asset growth, the bank has sustained a strong traction in fund-based revenues. The bank’s other income, however, continues to disappoint. An attempt to curtail operating overheads has got nullified by the higher provisioning and tax incidence.

Rs (m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Income from operations 16,940 21,859 29.0% 33,673 41,536 23.4%
Other Income 3,096 3,217 3.9% 5,183 5,993 15.6%
Interest Expense 9,123 12,952 42.0% 18,268 24,329 33.2%
Net Interest Income 7,817 8,907 13.9% 15,405 17,207 11.7%
NIM (%)       3.3% 3.0%  
Other Expense 5,960 5,968 0.1% 10,566 11,484 8.7%
Provisions and contingencies 1,257 1,593 26.7% 4,341 4,648 7.1%
Profit before tax 3,696 4,563 23.4% 5,681 7,068 24.4%
Tax 1,106 1,680 51.9% 1,520 2,551 67.8%
Profit after tax/ (loss) 2,590 2,883 11.3% 4,161 4,517 8.6%
Net profit margin (%) 11.9% 17.0%   10.0% 13.4%  
No. of shares (m)       293.2 364.3  
Diluted earnings per share (Rs)*       28.4 24.8  
P/E (x)         11.2  
* (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 12.9% in 1HFY07), 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 2QFY07?
Asset growth – Outperforming peers: Bank of Baroda registered a 45% YoY growth in advances in 1HFY07, with the retail book (20% of total advances) spearheading the growth in domestic advances at a growth rate of 56% YoY. The bank has a substantial market share in farm credit that grew by 44% YoY. The current rate of growth in the bank’s asset book is more than double the average clocked by the bank over the last 4 fiscals. The same is therefore not sustainable going forward, given that he bank’s deposit growth is not commensurate with its advance growth. Although the proportion of CASA in 1HFY07 has not been divulged, we estimate that the same continues to remain at about 38%. Despite this, the bank has faced some margin pressures in 1HFY07, which indicates that the higher growth in advances has been funded by high cost term deposits. The bank’s NIMs are in line with our FY07 estimation of 2.9%.

Bank of Baroda’s global portfolio continues to incrementally contribute higher to its asset book and the bank had 15% of its business exposure (deposits and advances) overseas at the end of 1HFY07. In terms of profitability, the international operations contributed 28% of the bank's profits at the end of FY06. While the bank’s global advances grew by 45% YoY, the global deposits grew by 25% YoY.

Other income – Lack of visibility: Bank of Baroda's fee income has not only remained stagnant at 30% of total income (in 1HFY07) as was the case in FY02, but as a proportion of total income it has infact reduced from 10% in FY02 to 8% in 1HFY07. Although, the investment book of the bank is no more 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. Nonetheless, the bank has 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.

Costs to even out: The bank had a cost to income ratio of 51% in 1HFY07. 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. We have estimated Bank of Baroda's cost to income ratio to come down to 51% in FY09E from 54% in FY06.

NPAs – Well covered: The bank, however, saw no negative surprises emanating on the NPAs side with both gross and net NPAs reducing to 3.4% and 0.8% of advances respectively in 1HFY07, from 6.3% and 1.1% respectively in 1HFY06. 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 278, the stock is trading 1.2 times our estimated FY08 adjusted book value. After a slag period in the beginning of this decade, Bank of Baroda maneuvered its 'image-rebuilding' exercise since FY05 so as to stabilise its market share and reposition itself as a lead competitor to the players in the private sector. Not only did this effort pay off by helping the bank achieve one of the highest growth rates in FY06, but also strengthened its balance sheet to a considerable extent. 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 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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