SBI - Pain largely priced in - Centrum

While we remain cautious on asset quality trends for the next two quarters, a large part of stress seems to be priced in at current levels. SBI is much better placed vs peers due to 1) its ability to absorb asset stress and 2) relatively lower risk from restructured assets pool. With a large part of asset stress recognized (GNPAs high at 5.3%), we believe that incremental pain should recede beyond the next 1-2 quarters. Moreover, recovery rates should improve in response to the various recovery plans put in place by SBI including identification of specific large and mid-size corporate NPAs as its key recovery targets. Our stress case analysis reveals that, downside risk (10% to stress value of Rs1850) is outweighed by upside potential (23% to fair value estimate of Rs2550) implying a very attractive risk-reward equation. Anticipated improvement in macro-economic environment coupled with strong liability franchise, likely stabilization of asset quality matrix and strong capitalization should ensure expansion in current valuations. The stock trades at 1.0x FY14E ABV (standalone banking operations) and offers an attractive entry point for medium to long term investors.

- Asset quality concerns to persist for 1-2 qtrs: SBI's fresh slippages are stabilizing albeit at a higher level of 3% though the pipeline of restructured loans is coming down. We believe that the asset quality stress numbers could still remain high for 1-2 quarters (as against guidance of improvement) as knock on effect of continued moderation in economic activity is felt in the near term. That said, the fact that restructured book is materially lower than peers at ~5% of loans implies that risk of NPAs emerging out of the restructured assets is lower. With a large part of asset stress recognized (GNPAs high at 5.3%), we believe that incremental pain should recede beyond the next 1-2 quarters. Moreover, recovery rates should improve in response to the various recovery plans put in place by SBI including identification of specific large and mid-size corporate NPAs as its key recovery targets. The instructions from finance ministry regarding strict and aggressive recovery efforts on top 300 NPA accounts too should yield results.

- Stress case analysis: In our stress case analysis, we have assumed sustained stress in asset quality (3.5% slippage rate for FY13, FY14 and FY15) which leads to stress RoE of 13.7% for FY14 and FY15. The weakening in return ratio profile implies a lower valuation multiple of 1.0x considering cost of equity of 14% and growth rate of 3%. Collectively, the stress assumptions imply a stress case value of Rs1850 (Rs1250 for core banking and Rs600 for associates and subsidiaries), a downside of 10% from current levels. Importantly, the downside risk of 10% is far outweighed by upside potential of 23% to our revised fair value estimate of Rs2550.

- Well capitalized, cheap valuations: While asset quality stress is likely to persist for a couple of quarters more, it seems to be priced in at current valuations. Anticipated improvement in macro-economic environment coupled with strong liability franchise, likely stabilization of asset quality matrix and strong capitalization should ensure expansion in current valuations. The stock trades at 1.0x FY14E ABV (standalone banking operations) and offers an attractive entry point for medium to long term investors.

Source : Equity Bulls

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