We initiate coverage on the regional banking space with Overweight stance owing to banks in our coverage universe having: i) sound business fundamentals - healthy business growth prospects, strong margins and well-managed assets; and ii) attractive valuations - they are trading near their FY12 PBVs, and below their five-year average as well as at significant discount to large-cap banks' multiples. Our top picks are J&K Bank and Indian Overseas Bank (IOB).
n Strong business fundamentals. As per data envelopment analysis (DEA; refer our report 'Withstanding macro headwinds' dated 16 Mar '11) which measures banks' efficiency, all regional banks in our coverage score high, given sound business fundamentals - healthy capital adequacy (FY11e tier-1: +9%) due to recent capital infusion by the government that would help sustain growth; better margin of 2.7-3.7% vs. industry average of 2.5-3%; and healthy asset quality (net NPA below 1.5% and NPA coverage of +70%).
n Set to trade above their book values. Our coverage banks are likely to register good profitability - FY13e RoA and RoE of ~1% and 18-20% respectively. They are trading near their FY12 PBVs as well as below their 5-year average and at significant discount to large-cap banks' (PNB, BoB) multiples. We believe that sustained profitability would lead to higher FY12e PBV, of 1.1-1.4x.
n Our top picks - J&K Bank, IOB. We favor J&K Bank (better placed in the tight liquidity and rising interest-rate scenario) and IOB (improving loan growth and asset quality) as they are primed for strong earnings and profitability.
n Risks. i) Any slowdown in economic growth would impact loan growth and asset quality; ii) tight liquidity and rising interest rates would hurt spreads.
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
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