Investors can consider holding on to the stock of Indian Overseas Bank (IOB). Though the stock may carry limited downside risk, given the valuations, the stock may continue to underperform peers over the near term.
Business positives such as strong advances growth, good return ratios and a good distribution reach may be offset by concerns about a low provision cover, even as asset quality deteriorates across the banking sector. IOB is a Chennai-based mid-sized public sector bank with more than 1,900 branches.
At current market price of Rs 46, the stock is trading at a modest trailing one-year price earnings multiple (PEM) of 2.1; a huge discount to other PSU banking peers.
The stock is valued at just 0.4 times its December 2008 book value. It carries a dividend yield of 8 per cent, considering the dividend payout for this year.
IOB has delivered strong business growth (21 per cent), enjoys superior return ratios (ROE of 28 per cent and ROA of 1.3 per cent for FY08) and a diversified advances book which is adequately capitalised. It has a high credit-deposit ratio.
The bank has had higher exposure to export credit and the construction sector (based on March quarter numbers) and there is a risk of this leading to higher provisioning in the coming quarters.
Business
IOB's advances growth, at 30 per cent, is higher than the industry average of 21 per cent. Higher advances growth was contributed to mainly by growth in corporate advances, even as the retail segment was flat.
On the deposit front, the proportion of bulk deposits has come down from 20 per cent in March 2008 to 16 per cent in December 2008. Nevertheless, the proportion is high and puts pressure on the margins in terms of higher cost of deposits. The low-cost deposit proportion has come down from 30.93 per cent to 29.23 per cent in a year and this has further increased the cost of deposits.
Financials
IOB's advances grew at 31 per cent compounded annually in the last five years. Higher advances growth helped the bank's profit grow by 23 per cent annually. For the nine months ended December 2008, the net interest income of the bank grew by 25.4 per cent, aided by above-industry average growth in advances and improved margins. The net interest margin for the bank improved from 3.11 per cent to 3.15 per cent in a year; but this is a more muted rise compared to its public sector bank peers, due to the bank's high cost of funds. 'Other income' boosted by treasury gains helped the bank attain operating profit growth of 25 per cent.
The growth would have been higher but for higher operating expenses (grew by 29 per cent). The net profit growth of 12 per cent year-on-year saw slight moderation on the back of higher provisions for NPAs and wages.
Although the bank has made higher provisioning for NPAs, higher slippages left the provision coverage at 46 per cent. Though this is above RBI stipulated limits, it is among the lowest within PSU banks. The net NPA/Advances at 1.3 per cent are higher relative to several public sector banking peers.
The capital adequacy of the bank according to Basel-2 norms is 14.09 per cent which improved significantly from 11.85 per cent sequentially, as the bank raised Rs 955 crore of tier-2 capital and re-valued its fixed assets in the past quarter.
Outlook
Going forward, IOB may be vulnerable to the macro risks to the banking sector. Net profit growth could moderate if the bank sets aside higher provisions for NPAs and wages.
The 'other income' growth may slow down as bond yields harden. Falling credit growth may also put pressure on Net Interest Income growth. Higher competition for deposits at lower rates may force cost of funds upwards. However, weighed against this, further rate cuts, which appear quite likely at this juncture, may help offset some of these pressures.
IOB is in a better position than most of its peers in terms of the credit-deposit ratio which is as high as 79 per cent. Unlike other banks, the bank has opted for an in-house CBS solution which saved it considerable costs.
The proposed merger with troubled Shree Suvarna Sahakari Bank, where it takes assets and liabilities of the bank and not its branches, also creates uncertainty.
It owns 19 per cent equity in non-life insurance company Universal Sompo General Insurance and acquired 11.83 per cent in Asset Reconstruction Company owned by JM Financial, which may contribute to the bank's fee income stream in future.
Business positives such as strong advances growth, good return ratios and a good distribution reach may be offset by concerns about a low provision cover, even as asset quality deteriorates across the banking sector. IOB is a Chennai-based mid-sized public sector bank with more than 1,900 branches.
At current market price of Rs 46, the stock is trading at a modest trailing one-year price earnings multiple (PEM) of 2.1; a huge discount to other PSU banking peers.
The stock is valued at just 0.4 times its December 2008 book value. It carries a dividend yield of 8 per cent, considering the dividend payout for this year.
IOB has delivered strong business growth (21 per cent), enjoys superior return ratios (ROE of 28 per cent and ROA of 1.3 per cent for FY08) and a diversified advances book which is adequately capitalised. It has a high credit-deposit ratio.
The bank has had higher exposure to export credit and the construction sector (based on March quarter numbers) and there is a risk of this leading to higher provisioning in the coming quarters.
Business
IOB's advances growth, at 30 per cent, is higher than the industry average of 21 per cent. Higher advances growth was contributed to mainly by growth in corporate advances, even as the retail segment was flat.
On the deposit front, the proportion of bulk deposits has come down from 20 per cent in March 2008 to 16 per cent in December 2008. Nevertheless, the proportion is high and puts pressure on the margins in terms of higher cost of deposits. The low-cost deposit proportion has come down from 30.93 per cent to 29.23 per cent in a year and this has further increased the cost of deposits.
Financials
IOB's advances grew at 31 per cent compounded annually in the last five years. Higher advances growth helped the bank's profit grow by 23 per cent annually. For the nine months ended December 2008, the net interest income of the bank grew by 25.4 per cent, aided by above-industry average growth in advances and improved margins. The net interest margin for the bank improved from 3.11 per cent to 3.15 per cent in a year; but this is a more muted rise compared to its public sector bank peers, due to the bank's high cost of funds. 'Other income' boosted by treasury gains helped the bank attain operating profit growth of 25 per cent.
The growth would have been higher but for higher operating expenses (grew by 29 per cent). The net profit growth of 12 per cent year-on-year saw slight moderation on the back of higher provisions for NPAs and wages.
Although the bank has made higher provisioning for NPAs, higher slippages left the provision coverage at 46 per cent. Though this is above RBI stipulated limits, it is among the lowest within PSU banks. The net NPA/Advances at 1.3 per cent are higher relative to several public sector banking peers.
The capital adequacy of the bank according to Basel-2 norms is 14.09 per cent which improved significantly from 11.85 per cent sequentially, as the bank raised Rs 955 crore of tier-2 capital and re-valued its fixed assets in the past quarter.
Outlook
Going forward, IOB may be vulnerable to the macro risks to the banking sector. Net profit growth could moderate if the bank sets aside higher provisions for NPAs and wages.
The 'other income' growth may slow down as bond yields harden. Falling credit growth may also put pressure on Net Interest Income growth. Higher competition for deposits at lower rates may force cost of funds upwards. However, weighed against this, further rate cuts, which appear quite likely at this juncture, may help offset some of these pressures.
IOB is in a better position than most of its peers in terms of the credit-deposit ratio which is as high as 79 per cent. Unlike other banks, the bank has opted for an in-house CBS solution which saved it considerable costs.
The proposed merger with troubled Shree Suvarna Sahakari Bank, where it takes assets and liabilities of the bank and not its branches, also creates uncertainty.
It owns 19 per cent equity in non-life insurance company Universal Sompo General Insurance and acquired 11.83 per cent in Asset Reconstruction Company owned by JM Financial, which may contribute to the bank's fee income stream in future.
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