Indian Bank

INDIAN Bank is one of the oldest banks in the country. It is also one of the best-managed state run banks in India. Its performance in the last three years, since it absorbed all its accumulated losses in its capital, is at par with best in its industry. Investors are advised to consider it for long-term investment.
BUSINESS

Headquarted in Chennai, Indian Bank is a leading bank in South India with widespread presence in Tamil Nadu, Kerala, Andhra Pradesh and Pondicherry. It was nationalised in 1969. It is a medium-sized bank and its balance sheet size stood at Rs 84,122 crore in FY 2009. It has 1,642 branches.

In the current decade, the bank has seen a turn-around. At the end of March 2000, bad loans, or net non-performing assets, formed 16% of Indian bank’s net advances. In FY06 it absorbed all the losses in its capital, which fell to Rs 744 crore from Rs 4,574 crore in the previous year. Since then, Indian Bank’s profit has grown at compounded annual growth rate (CAGR) of 35% every year, while its balance sheet has grown at a CAGR of 21%. This shows that it has enough reach and scale to leverage.

GROWTH DRIVERS

Indian Bank’s performance is clearly a cut above most state-run banks, notorious for inconsistent performance that puts down investors. The bank has performed well on all quality parameters while maintaining an impressive growth rate, achieving a delicate balance that has eluded several of its peers.

For instance, its net interest margin (NIM) stood at more than 3.5% in last six financial years. The only banks, which can better Indian Bank on this count are Kotak Mahindra Bank, Federal Bank and HDFC Bank. Its return on assets (RoA), at 1.6% in FY 2009, was the highest across all banks.

Its bad loans formed less than 0.2% of its net advances at the end of the year. Only Punjab National Bank has better record than Indian Bank on this count. The composition of its lending portfolio is very much on the lines of other state-run banks: agriculture loans constituted 15%, SME loan formed 11% and corporate sector contributed 50% to total loan book.

That the bank’s performance is superior despite similar lending profile shows the efforts being put in to choose the customers. The bank is expanding its presence. It opened 101 new branches in FY 2009.

VALUATION

Indian Bank is trading at a price to earning (P/E) multiple of 4.8 times. This is lower than the average of smaller banks that are no match to it in performance.

This indicates that the stock market is not giving premium to its performance. Moreover, the earnings growth is far ahead of P/E, which shows that the possibility of rise in stock price is much higher. In terms of price-to-book value P/BV), the stock is trading at close to 1, which is the average at which other banks are trading. Even based on P/BV, the bank is not getting the premium it deserves in terms of valuations.

We think it will be re-rated some time in future and therefore advise long-term investors to buy the stock at current levels.

Financial indicators to gauge a company’s underlying health

WITH MARKET valuations having fallen drastically, many investors seem to be rummaging for value picks. But they must remember, all that glitters is not gold. An investor must have the skill to spot the good stocks from the bad ones. ETIG thought it a good idea to lay down the basic framework so that investors can zero in on the right stocks. Investors can consider certain financial indicators to gauge the underlying health of a company, which may not be adequately represented by its stock price.

BUSINESS MODEL:

One of the basic features of a stock is the business model of the company, which makes it a defensive or aggressive bet. A growth stock is likely to perform very well in a bull run, while a defensive bet may pay off in a bearish market. When buying stocks of commodity-based businesses, an investor should be aware of the specific commodity cycle and hence, the consequent cyclicity in the company’s earnings.

POSITIVE OPERATING CASH FLOW:

The net cash that a business generates through its operations, as reflected in the company’s cash flow statement, is also a critical feature. It is important for a company to have a positive cash flow from its operations. A company can report net profit in its profit & loss account without generating a positive cash flow from the socalled ‘profitable’ growth. Another parameter to be considered is free cash flow, i.e. the cash left with the company after capital expenditure (capex). Any company may have negative operating cash flow (OCF) for one or two years, but a good company with a sustainable business model cannot have a history of negative OCFs. Similarly, a well-managed company should not have negative free cash flow for many years in a row.

RELATIVE VALUATIONS:

The price-to-earnings (P/E) multiple of a company cannot be an important indicator by itself, unless it is considered in comparison with the P/E multiples of other companies in the same sector, or against the company’s own historical P/E, or against the market’s P/E.

DEBT-EQUITY RATIO:

This is a critical tool to measure a company’s leverage. A low debt-equity ratio is generally preferred, but is not always necessary. Companies in capital-intensive sectors like infrastructure, real estate, cement, steel and oil & gas typically have high debt-equity ratios, while those in sectors like FMCG, IT and pharmaceuticals generally have low debt-equity ratios.

The phase of a company’s growth is also an important factor to be considered. A company in a growth phase may, at times, choose to leverage itself more than ideally required, against a company that has an established business. Higher debt increases the finance costs, which can be costlier to service in a high interest rate regime. Conversely, raising money through equity can be difficult during a bear phase.

INTEREST COVERAGE RATIO:

The company’s ability to service its debt is another important criterion to judge its health. The lower the interest coverage ratio, the more difficult it is for the company to service its debt. Investors should consider the debt-equity and interest coverage ratios simultaneously. Suppose a company has high debtequity ratio, but it also has high interest coverage, then it is in a good position to service its debt.

PRICE-TO-BOOK VALUE (P/BV):

This ratio of the stock’s market value to book value helps in knowing its relative under or over-valuation. A lower P/BV multiple typically indicates that the stock is under-valued, but this may not always be the case. Again, this ratio varies from industry to industry. A capital-intensive industry will typically have a lower P/BV multiple. Banks generally use this ratio, because unlike manufacturing companies, they measure their assets at market value. Since book value takes into account only tangible assets and liabilities, this ratio may not be useful for companies holding a significant intellectual property, or an FMCG company with many brands.

RETURN ON CAPITAL EMPLOYED (RoCE) & RETURN ON NET WORTH (RoNW):

For a company, RoCE and RoNW should be significantly higher than the prevailing interest rate. If a company’s RoCE is consistently lower than say 15%, that is not a healthy sign and it indicates an economically inefficient operation. However, any good company may report lower RoCE or RoNW during an economic downturn or high investment phase. So it’s always helpful to compare RoCE or RoNW on a historical basis. But it doesn’t make sense to compare RoCE of two companies in two different sectors. It’s best to compare it with peers in the same or related industries.

DIVIDENDS:

A company which consistently pays dividends implies it’s rewarding its shareholders. Preference should always be given to a company with higher dividend yield. Higher the yield, more is the investor’s return on his/her investment. However, long-term investors should be wary of companies which dole out dividends at the cost of growth. It is also important to compare growth in dividend to growth in profit. A corresponding growth in dividend and profit indicates that the business model is sustainable and the company is confident of its cash flows. It also signals the management/promoter’s willingness to share the growth with the company’s shareholders.

MANAGEMENT OR PROMOTERS’ CREDIBILITY:

Last, but not the least, while fishing for a good stock, investors must also scrutinise the promoter’s credibility. A corrupt and fly-by-night management can inflict greater damage on a company than any other factor. This explains why companies owned by reputed and well-regarded business houses are widely sought-after on the bourses.

Stock Views on Indiabulls Real Estate, OnMobile Global

Deutsche Securities on Indiabulls Real Estate - TARGET PRICE: RS 300

Deutsche Securities has initiated coverage on Indiabulls Real Estate with a ‘hold’rating as it feels the company has limited track record in execution. Weakness in the Mumbai office market for highend office properties, and a large free float — which allows much larger head-room for “borrowing” and selling short — are downsides for the stock. According to a Deutsche Bank note, Indiabulls’ revenue growth would be driven by volumes and stake sale of associate and/or subsidiaries. “We expect a revenue CAGR (compound annual growth rate) of 41% over FY08 to FY11 (estimated). We expect EBITDA margins to drop from 72% in FY08 to 55% in FY11 (estimated), mainly driven by higher costs (land, construction, employees, SG&A). Further, we expect the tax rate to increase from around 28% in FY08 to nearly 30% in FY11 (estimated). Thus, while we expect volume growth (around 40%), we expect PAT (profit after tax) to grow by only a 19% CAGR over FY08-11 (estimated),” the note to clients said. However, the Deutsche Bank note added that the demerging and listing of its forays in power and retailing would drive growth and shareholder value in the near term. Meanwhile, SEZs, townships and annuities from com-pleted projects will drive long-term growth, it added.

Citigroup Global on ONMOBILE GLOBAL - TARGET PRICE: RS 630

Citigroup Global Markets has initiated coverage on OnMobile Global with a ‘buy’ rating saying OnMobile Global is India’s largest VAS (valueadded services) operator (35% share) in a rapidly growing market [FY08-11 (estimated) CAGR at 51%. The estimated 36% EPS (earnings per share) CAGR over FY08-11 (estimated), was due to the company’s increasing international presence, said Citi. “Though it ap-pears high in the current environment, we believe our target PE (price to earning) of 25x Mar-10E is justified by OnMobile’s strong growth prospects and is in line with the multiple for comparable peers,” the note added. According to the Citi note, the domestic VAS has gradu-ated from being a glorified sub-set of p-to-p SMS to a well-demarcated segment.