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SBI: Flying on consolidation hopes? - Views on News from Equitymaster

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SBI: Flying on consolidation hopes?
Dec 7, 2006

Banking stocks, that until the fag end of FY06 remained distanced from investors’ horizon, cornered most of the gains seen in the post correction rally (May 2006 onwards). Of them, while the private sector banks were undoubtedly the cynosure of everyone’s eyes, select PSU banks like SBI also generated much fervor. While the BSE Sensex gained 53% from December 2005 to December 2006, SBI’s stock price trailed close behind gaining 44% during the same period. The banking behemoth has a weightage of 3.9% and 3.6% on the Sensex and Nifty respectively and its contribution to the market rally cannot be undermined. Lingering problems but…
The change in the computation of commission on government business (of which SBI has 60% market share), from value to volume based, has led to fall in fee income from the same by 13% YoY. While government business (collection of taxes) comprises 12% of SBI’s other income, total fee income comprise 17% of the bank’s total income.

SBI’s staff costs registered a growth of 7% YoY in 1HFY07 after the wage revision done in the corresponding period of FY06. As per the bank’s estimates, if the higher contribution to pension fund (decision pending in court) were to be written off in a single fiscal (as against being deferred), it would erode a year’s profits for the bank (approximately Rs 40 bn). The cost to income ratio that currently stands at 52% will reduce going forward as 38,000 employees retire from the bank’s payrolls by 2010.

Treasury kicker
Given that SBI has more than 80% of its investments in the GSec portfolio, the 100 basis point correction in the benchmark 10 year GSec yield from 8.4% in June 2006 to 7.4% currently, the banking behemoth’s treasury portfolio is expected to yield tempting returns in the current fiscal, if the softness in bond yields continue. This will also partially make up for the higher provisioning the bank needs to make for its operating costs and further write off some its NPAs.

Consolidation hopes
A consolidated picture of SBI and its seven associates certainly allure substantial investor interest given the mammoth asset size, largest franchise and customer base. Besides, unlike subsidiaries of most other bank, SBI’s associates are in a better financial condition than the parent bank in some parameters (CAR, NPA) while they are at par with SBI in other cases. Also, SBI’s life insurance subsidiary that is expected to list in FY10, (as per IRDA norms) is the first private sector life insurance company to break even. Value unlocking from such factors makes the bank worth a long-term investment.

Reality check!
While it is comprehensible for investors to value SBI based on its consolidated valuations, they must keep in mind that the valuations accorded to it are reasonable. When we value SBI and its listed associates as a multiple of their adjusted book value and take the book value of the unlisted entities, the consolidated valuation gives us a target price that does not make fresh investment in the stock reasonable at the current levels (see table below).

Another fact that retail investors need to keep in mind is that the bank’s limited FII investment limit (20%) has not been hiked, leading to the stock triggering speculative transactions amongst FIIs themselves. Such actions on the market warrant little fundamental merit and pose considerable risk for the ignorant retail investor.

  FY05 FY06 FY07E FY08E FY09E
Listed associates
SB of B&J (75%) 9,577.0 10,373.3 12,448.0 14,937.6 17,925.1
SB of Mysore (92.3%) 4,295.2 6,901.8 8,282.1 9,938.6 11,926.3
SB of Travancore (75%) 8,339.4 9,827.2 11,792.6 14,151.2 16,981.4
  22,211.6 27,102.3 32,522.8 39,027.3 46,832.8
      20% 20% 20%
Value of SBI's share in associates 42.2 51.5 61.8 74.2 89.0
1.5 x ABV 63.3 77.2 92.7 111.2 133.5
SBI + Listed subsidiaries 697.9 833.5 960.9 1,139.5 1,355.0

While we wish to reiterate the fact that SBI merits a re-rating going forward, in the event of its associates getting merged and subsidiaries getting listed, investors must have patience for the events to unfold or atleast get some clarity on them. Meanwhile, while the current valuations make the stock adequately priced, holding a banking behemoth like SBI from a long-term perspective needs no further justifications.

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