Corporation Bank: Buy

Among listed public sector banks, the Corporation Bank stock, at its current price of around Rs 350, provides a good medium-term investment opportunity.

The stock trades at around 1.3 times its March 2007 book value and about 9.3 times its March 2007 earnings.

Investors with an investment horizon of at least one year can take exposure at current levels.

An investment horizon of less than a year may generate decent returns provided some weakness is seen in the stock. Short-term investors can pick up the stock for quick gains at lower levels than currently.

The stock has a notable correlation or relationship (though not very strong) with the Junior Nifty as well as the sectoral bank index (Bank Nifty). Based on price changes in the stock and the broader market in the past year, the stock moves by around 1.25 times the broader market change, suggesting that any overall market correction could provide good opportunities for picking the stock at lower levels.

Solid profile

Overall, the bank shows steady and solid fundamentals that can generate decent, positive, real returns (inflation-adjusted) over the medium term.

The inherent constraints in being a public sector bank, however, show up in many areas of business.

Such constraints have meant that the bank has not been able to capitalise on business opportunities to the fullest measure.

For instance, the bank has been able to double its balance-sheet in the last five years — which indicates an average rate of business growth of about 15 per cent.

There are banks in the private sector, though, that have done this in half the time — particularly in the last two years as the economy expanded and provided high growth opportunities for financial intermediaries.

A growth rate of 40 or 50 per cent in key parameters such as deposits/advances has become almost normal for some private sector banks in recent times.

Though having an ideal platform in terms of a clean balance-sheet at the turn of the decade, a reputation for nimble-footedness, initiative, relationship building and networking, good systems — both IT and non-IT — Corporation Bank's growth the last five years is somewhat disappointing.

The Government of India holds a 57 per cent stake in the bank and as per current law, its holding cannot go below 51 per cent.

This puts constraints on business growth in public sector banks as fresh capital infusion has to be structured without diluting government holding.

The regulatory ceiling on the amount of Tier 1 perpetual and Tier 2 hybrid debt capital that can be raised also acts as a restraint.

Frequent public issues of capital, of course, will not be favourable from a valuation perspective; it would be ideal if business growth can be supported only by growth in retained earnings/debt.

The point, though, is that the enabling environment is not exactly complete for public sector banks.

For instance, it may not be possible for them to replicate the marketing strategies of private sector banks in the retail space to register growth in retail loan portfolios.

While the above argument applies broadly to public sector banks, it has to be suitably modified for banks such as Corporation Bank that have a good cushion at the existing level of capital itself.

Corporation Bank's capital adequacy, as of March 2007, is 12.75 per cent against the regulatory norm of 9 per cent. This means the bank has a good cushion to expand the level of risk assets without the need for fresh capital infusion.

Well-placed among peers

Though not comparable in size, Corporation Bank stands out on some key efficiency parameters such as overall profitability of the underlying business, the structural make-up of its balance-sheet in terms of the proportion of low-cost liabilities and the cushion provided to the earnings stream by non-interest income.

The bank also has a well-distributed network of around 900 branches, which will be the key in sourcing new business — particularly from the retail segment.

Retail credit currently forms around 25 per cent of the total and this could be an area for aggressive growth in the ensuing period.

Stability to earnings

Not only will margins in certain segments of the retail business be higher — for example, in credit cards and personal loans — but the overall retail business would also provide more stability to the earnings stream and could offset income variability from other business segments such as corporate/commercial banking.

The level of impaired assets on the balance-sheet is very low at around 0.50 per cent.

This could provide the flexibility for the bank to ramp up asset growth.