Union Bank of India - Modest profitability ahead, but negatives priced in; Hold - Anand Rathi

Slow credit growth, NIM to be constrained. Over FY10-13, the Union Bank of India's advances registered a 20.4% CAGR, faster than the sector's 17.5% in the same time. Ahead, we estimate a 15.5% CAGR in advances over FY13-15, led by the SME, retail and working capital segments. Due to a relatively low share of CASA (31% of deposits) and a stretched credit-to-deposits (78.9%), NIM is likely to be anchored at 2.7% over FY14-15.

Weak fee income, Treasury gains to drive other income. The bank's fee-based income is likely to be weak, given the modest credit growth outlook. We estimate fees-to-average-earning-assets at 34bps over FY14-15, one of the lowest among large-cap peers. However, a high proportion of available-for-sale investments (22.2%), with modified duration (~3 years) would augur well for Treasury profits in a falling interest-rate environment.

Stable asset quality, but low capital adequacy. The slowing economy has weighed on the bank's asset quality in FY13, with gross NPA at 3% of loans and incremental slippages at 1.9% of loans. While NPA coverage has improved 239bps in FY13 to 46.9%, restructured assets at 6% (Rs. 116bn) is the lowest among large-cap PSU peers. However, with a restructuring pipeline of Rs. 22bn (1.1% of loans) in 1HFY14, asset quality concerns persist. Despite the recent capital infusion by the government, capital adequacy at 11.4% (tier-1 capital of 8.2%) is insufficient to support long-term business. In our view, the bank would require further capital infusion in CY14.

Our take. Due to lower credit growth assumptions, we slash our FY14 and FY15 net profit estimates 20% and 17.6% respectively. Hence, we lower our target from Rs. 254 to Rs. 235. On fair valuations (0.8x FY14 PABV), we maintain a Hold and believe that further re-rating is likely only when asset quality and profitability consistently improve. At our Mar'14 target, the stock would trade at a PABV of 0.9x FY14e and 0.8x FY15e. Our target is based on the two-stage DDM (CoE: 14.6%; beta: 0.9; Rf: 8%). Risks. Downside - sustained sharp increase in defaults. Upside - sharp rise in credit growth and net-interest margins.

Source : Equity Bulls

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