(BSE: 532461 | NSE: PNB | ISIN: INE160A01014)
Punjab National Bank (PNB) is the third largest PSU bank in India with a dominant presence in north India . The bank has adopted a strategy of moderate growth, focusing more on margin protection thereby improving its profitability and return ratios. We expect earnings to grow at a CAGR of 21% over FY07-09E to Rs 2,243 crore. We initiate coverage on the bank with an outperformer rating.
Extensive branch network with 50% rural presence to boost fee income PNB has got an extensive branch network of 4563 branches, with 50% in rural areas giving it an unparalleled advantage of higher CASA and consequent lower cost of funds. Its reach is expected to help the bank’s ambitions to grow fee based income through cross selling, as rural markets will be providing sizeable opportunities to sell insurance, mutual funds, etc products as compared to matured & penetrated markets. Higher NIMs sustainable with asset quality on a roll We expect PNB will be able to sustain its NIM’s at 3.75% levels, higher than its peers, on account of 46% CASA. We believe net NPA’s to stay at 0.7-0.9% levels which should be a commendable achievement considering the size of the bank.
Good play in the Consolidation Space PNB has made seven acquisitions till date giving enough agility to emerge as a better suitor to absorb smaller & weaker banks during consolidation activity expected in the sector going forward.
Valuations We expect ROA to rise from 1% in FY07 to 1.1% levels in FY09 with ROE improving from 15.6% to 17.4% during the same period. At CMP of Rs. 498, PNB is trading at 1.2x its FY09E ABV and 7x its FY09E EPS of Rs.71.1 which is quite attractive. Higher CASA with higher return ratios should boost bank’s valuations going forward. Expansion in RoE with cost of equity at 13.2% gives a theoretical P/BV at 1.4x. At 1.4x FY09E core ABV, we get a price of Rs 627. PNB has a 25% stake in UTI AMC on account of which a further Rs 20 per share is added to valuation. This gives a target price of Rs 647, an upside of 30% over a 9-12 month time frame.
Company background Punjab National Bank is northern India based third largest PSU bank in India with 4563 Offices including 421 extension counters through which it serves its over 3.5 crore customers. PNB was established in 1895 at Lahore , undivided India . From its modest beginning, the bank has grown in size and stature to become a front-line banking institution in India at present. It has strong correspondent banking relationships with more than 217 international banks of the world. In FY07 total business grew 21% to Rs. 2,36,456 crore. PNB has got two subsidiaries PNB Gilts Ltd and PNB Housing Finance Ltd. Out of these PNB Gilts is listed on the bourses and currently trades at Rs. 21. PNB had come out with its follow on public offering recently in FY05 at a premium of Rs.380 per share. PNB, after upgrading its representative office at London into a wholly owned subsidiary, is also looking to open an offshore banking unit at Singapore and a subsidiary at Canada . PNB has already been granted a licence by the Hong Kong Monetary Authority for setting up a branch at Hong Kong .
Investment Rationale Strong deposit franchise giving highest CASA PNB has got one of the highest CASA deposit levels among PSU banks. CASA deposits account for about 46% of total deposits. Historically, the bank has had a high CASA level and is expected to maintain it going forward, being a large player in rich northern belt of India . A higher portion of low-cost deposits has seen the bank manage its interest expense effectively resulting in comparatively lower erosion of its NIM’s and reduce volatility in earnings.
PNB has a strong network of 4,563 branches, which it uses efficiently to fund its resource requirement. We expect new branches addition only to the tune of 50 -100 to cover some major non-banked regions only. Also, a few unwarranted branches may be closed. PNB’s chairman has articulated its intentions of opening smaller branches or extension counters with lesser staff in rural areas to garner more deposits and expand business in future. Total deposits have grown 16.9% y-o-y in FY07 to Rs 1, 39,860 crore. We expect deposits to grow at a CAGR of 17% to Rs 1,91,562 crore with process re-engineering on way to move to mass banking from class banking under new leadership.
Loan growth remains healthy The bank’s loan book grew at 29.4% y-o-y in FY07 to Rs 96,596 crore. The growth was triggered by robust increase in corporate advances. PNB is strong in agricultural sector with priority sector lending at 44%. Retail advances grew at a lower rate of 21%. The retail loan portfolio accounted for 22% of total credit. Going forward agriculture, SME and retail advances will be the main thrust areas for the bank. We expect credit to grow at a CAGR of 21% over FY07-09E to Rs 1,405,611. According to the latest June quarter results (Q1FY08), corporate and SME advances accounted for 37% of total advances, retail (22%) and priority sector (41%). PNB had hiked its deposit rates in FY07 along with other banks. The impact should be felt in FY08 to the tune of at least 40-50 bps based on partial repricing of deposits. We have seen a rise in costs of funds from 4.16% to 4.40% in FY07 and we expect them to rise further to 5.01% by FY09E. In FY09, a steep rise in cost of funds is not expected as the management has taken a conscious decision to discontinue high-cost deposit schemes in Q1FY08. The bank’s PLR was hiked 3-4 times leading to a rise in yield on advances to 8.93% in FY07 from 7.91% in FY06. We expect yields to rise to 9.25% during FY08E. We believe the benefits of these increase in yields and costs will show its full impact in FY08 and FY09 and NIMs will remain stable from 3.77% in FY07 and to 3.76% in FY08E and 3.75% in FY09E. PNB operating expenses to average assets ratio has improved from 2.9% in FY05 to 2.2% in FY07. With over 4,000 employees due to retire in the next three years, we expect employee costs to grow at a CAGR of 15% over FY07- 09E and overall operating expenses at a CAGR of 14%. As there is no major addition in branches, operating expenses to average assets ratio is expected to come down to 2% by FY09. These ratios are excluding provision for transitional liability. The transitional liability on account of pension due to revised AS-15 is estimated at Rs.1000 crore which we are amortizing against profits over a 5 year period in our estimates.
Fee income growth initiatives taking shape In FY07, PNB witnessed one of the best growths in its fee income with commission, exchange and brokerage income rising 29% y-o-y to Rs 970 crore from Rs 752 crore. Profit from exchange transactions grew a healthy 44%. PNB plans to foray into life insurance by forming a joint venture. It is also among the front runners for managing the government’s pension fund. But these steps may take time to generate revenue. We have factored a conservative growth in fee income at a CAGR of 19% over FY07-09E to Rs 1,373.5 crore.Total non-interest income dipped 15% in FY07 on account of a loss of Rs 386.70 crore due to transfer of securities to HTM category. After Q1FY08, about 83% of the bank’s SLR is in HTM category, thereby reducing MTM losses to some extent. We expect PNB to deliver non-interest income growth at 24% over FY07-09E to Rs 1,605 crore from Rs 1,042.3 crore.We expect initiatives on cross-selling of a wide range of banking services and insurance, credit and investment products to its customers to take shape as a critical aspect of its retail strategy.
Healthy asset quality for a sizeable bank We are expect marginal rise in net NPA levels from 0.75% to 0.86% in FY08 on account of loan loss provisioning seeing a slight slowdown as excess pension liability provision kicks in. However, FY09 should bring loan loss 10% provisioning back on track above 75% levels as profits will be adequate % enough to take care. We expect net NPA levels to hover around 0.7 -0.9% in next couple of years. Asset quality has improved a lot since FY05 declining from a peak of 6.19% to 3.5% and with recoveries expected to be in line with fresh slippages gross NPA are estimated to decline further to 2.58% by FY09E. PNB has got excess floating provisions to the tune of Rs. 980 crore which it can utilize for future offsetting with RBI’s approval.
Headroom available for future capital raising The government’s stake at 57% leaves space available for raising capital in future to boost the balance sheet growth. However, strong internal accruals and moderate credit growth would help it avoid tapping the capital markets in near future. In FY07, the bank’s capital adequacy ratio (CAR) was 12.29% and with internal accruals and debt issuances, the bank is expected to maintain its CAR above 10%.
Opportunities at Consolidation time… With Tier I funding cushion available, we expect the bank to play a bigger role in the consolidation of the banking sector from 2009 onwards. We believe the biggest player, SBI, will focus on consolidating its subsidiaries first. PNB, besides Canara bank are the two biggest players in the PSU banking space based on their size to absorb smaller PSU banks. PNB has till date made seven acquisitions giving enough agility to emerge as a better suitor in consolidation activity expected in the sector going forward.
Valuation We expect ROA to rise from 1% in FY07 to 1.1% levels in FY09 with ROE improving from 15.6% to 17.4% during the same period. At CMP of Rs. 498, PNB is trading at 1.2x its FY09E ABV and 7x its FY09E EPS of Rs.71.1 which is quite attractive. Higher CASA with higher return ratios should boost bank’s valuations going forward. ROE’s expansion with cost of equity at 13.2% gives a theoretical P/BV at 1.4x. At 1.4x FY09E core ABV we get a target price of Rs 627 for bank.
Opportunity for value unlocking of stake in UTI AMC PNB has got a 25% stake in UTI AMC of which 12.5% is expected to be offloaded by the end of FY08 on account of UTI AMC’s listing. UTI AMC’s 25% stake is valued at Rs.662 crores (valued at 5% of UTI AMC’s FY09E AUM of Rs.52993 Crores), giving Rs.21 per share of PNB. Thereby, Rs 20 per share can be added to the stock price. Based on the above two factors we arrive at a target price of Rs.647 an upside of 30% over the time frame of 9- 12 months.
Quarterly performance Net Profit for Q1FY08 saw a growth of 15.2% to Rs. 425 crore from Rs.367.5 crore in line with expectations. However, Net Interest Income growth was marginally slower at 6.6%. Deposits and advances grew 21.7% and 23.3% y-o-y respectively thereby leading to business growth of 22.4% to Rs.238249 crore. Non-Interest income excluding the loss incurred on transfer of securities increased by 47% to Rs 432 crore at the end of June 2007 from Rs 293 crore at the end of June 2006. Overall the quarter showed moderate growth across all sectors, barring a slight dip in CASA which was seen across the industry due to shift by investors to term deposits from savings deposits
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Source ICICI Direct Research Services
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