South Indian Bank

South Indian Bank is a conservatively run South-based bank. It is now trying to grow its branch network in the North as well. In recent times, the bank has also upgraded itself technologically. Its low current valuation and attractive growth prospects make it a good pick for the long-term buy-and-hold type investor.

 

Sectoral outlook

Today most analysts are bullish on the prospects of banking. With credit growth expected to improve (it has picked up to around 16 per cent already and will only rise further) as the economy returns to high-growth mode, this sector is expected to do well over the long term.

 

With regards to valuation, both public sector and private sector banks are attractively priced currently. However, there is some concern about public sector banks at present. Says Ashish Kapur, chief executive officer, Invest Shoppe India: "Many public sector banks hold large amounts of government paper. As interest rates go up (the first of the rate hikes was announced by RBI recently on March 19), they will suffer mark-to-market losses on these holdings."

 

Besides, over the last 18 months private banks have grown their books slowly. Today they have high capital adequacy ratio and are well poised to benefit from the upturn. PSU banks, on the other hand, have been aggressive over the last 18 months. Analysts fear that these banks could face asset-quality pressures in the near future.

 

Strengths

Well capitalised. South Indian Bank has a strong capital adequacy ratio of 16.12 per cent and tier I capital of 14.3 per cent. This will allow the bank to grow its advances at above-industry rate.

 

Low-cost deposits. NRIs contribute 20 per cent of the bank's deposits and CASA (current account savings account) deposits comprise another 25 per cent. Thus 45 per cent of the bank's deposits are low cost.

 

Branch network. The bank has a network of 575 branches. Earlier it was present only in South India. But now it is expanding its network in the North as well.

Tech savvy. Over the last three years the bank implemented core banking solution (CBS) in all its branches. This has enhanced its cost efficiency and imparted greater stability to its earnings.

 

Low NPA, high margin. South Indian Bank's NPA levels (gross NPA of 1.5 per cent and net NPA of 0.4 per cent) are among the best in the industry. Its net interest margin of 3.1 per cent is also high.

 

Robust recent results. n Q3FY10 its net interest income (NII) rose by 17.5 per cent and its net profit by 15.2 per cent.

 

Strong gold loan portfolio. Gold loans, which comprise 28 per cent of its incremental loans, account for a substantial portion of the recent expansion in the bank's credit book. Due to the collateral in the form of gold, this is a safe loan for the bank to give out. Bancassurance tie-up with LIC. To enhance its 'other income', the bank has entered into a bancassurance tie-up with Life Insurance Corporation for selling the latter's insurance policies.

 

Weaknesses

Regional player. Being concentrated chiefly in the south, SIB is more of a regional bank. Says Vaibhav Agrawal, vice-president, banking research at Angel Securities: "Such a bank will always trade at a discount to frontline national players."

 

Middle-East crisis. The Dubai crisis led to concerns about the possible impact on SIB since a large percentage of its NRI customers reside in the Middle East.

 

Management

Under V. A. Joseph, the current managing director and chief executive officer, the bank's return on equity has gone up. After joining the bank in 2005, Joseph introduced performance-linked compensation. Technology upgradation and brand-building were also initiated. "South Indian Bank's management is clearly superior to that of other regional banks. It always manages to outperform whatever guidance it provides to the market," says Agrawal.

 

Growth opportunities

Branch expansion. The bank plans to grow its number of branches from 575 currently to 750 by 2013. Economic upturn. Demand for credit is likely to go up because of the economic upturn. Analysts are now assuming a GDP growth rate of 9 per cent for FY11. If we assume a credit growth multiplier of 2.5, then credit is likely to grow at the rate of around 22.5 per cent, much higher than the current rate (16 per cent). Improvement in credit demand will boost the bank's core performance.

 

Threat

The key threat to this stock as well as to the banking sector as a whole comes from the expected increase in interest rates during the year. When interest rates rise, banks suffer mark-to-market losses on their bond holdings. This is expected to adversely affect the 'other income' component of banks' profit and loss statement.

 

Valuation

At the current price of around Rs 155 per share, the bank is trading at a valuation of around 0.8 times its adjusted book value for FY11. By all accounts, this is an attractive valuation. The market is pricing the stock so inexpensively because of the expected interest rate hikes during the year.

Once this period of rate hikes gets over, the stock's valuation is likely to improve. Angel Broking's PAT growth estimate for South Indian Bank is 40.5 per cent for FY10E, a sharply lower 11.7 per cent for FY11E, and then up again to 24.3 per cent in FY12E.

 

Should you buy?

Over the last five years the bank's EPS has grown at a compounded annual rate of 71.56 per cent. SIB may not be able to sustain that kind of growth rate on a higher base, but even half that rate would be attractive. Analysts believe that the stock can provide a return on equity of around 17 per cent for the next three years.

 

It is this combination of low current valuation and attractive growth prospects that makes South Indian Bank a stock you should hold in your portfolio for the long term (three years or more).