The name u can bank upon... RE-INITIATING COVERAGE

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1 The name u can bank upon... RE-INITIATING COVERAGE Industry Mr K R Kamath Chairman & Managing Director Punjab National Bank (O) , Stock metrics Bloomberg code Reuters code BSE Group PNB.IN PNBK.BO Code NSE Symbol A PNB Face Value Rs 10 Market Data Market Cap (Rs cr) WeekHigh/Low 1058/581 Sensex Nifty Average volume Shareholding Pattern : Govt M F & UTI Insurance FII Non-Institutions Fis & Banks Research Analyst Anshuman Jain anshuman.jain@inventuregrowth.com Extn: 579 Denil Savla denil.savla@inventuregrowth.com Extn: 581 Date: 28 th May, 2010 Banking 57.8 Punjab National Bank I N V E N T U RE Initiating snippets for covering Punjab National Bank Punjab National Bank (PNB) established in 1894, is the second largest bank after SBI among the Public Sector Banks and has one of the largest network in India with more than 5000 domestic branches and 4 foreign branches. With representative offices and branches, the bank has extended its presence in 8 countries across the globe. Recently PNB acquired more than 63% stake in Kazakhstan based Dana Bank and started a Joint Venture Bank in Bhutan and Nepal and a branch at DIFC, UAE. PNB increased its NIM to 3.99% for the Q4FY10, which is one of the best among the PSU banks. Good Capital Adequacy Ratio: PNB s capital adequacy ratio is one of the best in the sector at 14.16% at end March, 2010 against the stipulated norm of 9% (Tier-I Capital: 9.15% Tier-II Capital: 5.01%). On the growth trajectory: PNB has undergone a business restructuring exercise setting a platform for quality business growth in the near term. The total advances grew by 20.6% y-o-y growth with the CD ratio reported at % as at March, Better NIM at 3.57% and improvement of CASA will continue to support bank s margin strongly. Valuation: At CMP of Rs 983 PNB trades at PE of 7.9x of FY10 earnings and 6.9x and 5.9x of FY11 and FY12 estimated earnings with EPS of Rs and Rs of FY11E and FY12E respectively. We re-initiate coverage with a buy rating on the stock with a target price of Rs 1173 (1.8x of ABVFY12E). Key Financials Current Price Target Price Rs. 983 Rs Potential Upside 19% Year Ended March FY09 FY10 FY11E FY12E NII Other Income Net Profit EPS(RS) P/E(x) P/BV ROE ROA ABV per share (Rs)

2 Table of Contents Serial No. Particulars Page No. 1. Company Profile 3 2. Key Investment Criteria 4 3. Key Investment Concerns 7 4. Banking Overview 9 5. Summary and Conclusions Charts Profit and Loss Statement Balance Sheet Financial Valuation and Ratios Peer Comparison 17 2

3 Second largest PSU bank in terms of branch network and business size. To boost CASA deposits.the bank has started a pilot project in the unbanked villages called Project Namaskar. Brief Profile of Punjab National Bank: Punjab National Bank is the second largest state owned bank in the country with a strong presence in North and Central India. Established in 1894, it has a loan book of approximately US$40B that has grown by CAGR of 20% over FY It is one of the most technologically advanced public sector bank with the government owning 57.8% of its equity. PNB has one of the best liability franchises with CASA of 41% leading to relatively high NIMs among PSU banks. It has gross NPA of 1.8% and the management expects to maintain it around the same levels in the current fiscal. In addition the bank reported a superior NPA coverage of 81% (inc. technical w/offs) in FY10. In terms of network, PNB is the second largest bank in the country and also in terms of business size it is the second largest PSU bank in India. The total of bank branches stands to more than 5000 domestic branches. The bank has operationalised 523 specialized MSME branches/focus branches to provide hassle free credit, single window services to SME borrowers. Under branchless banking model of financial institution, PNB is implementing 46 projects in 17 states. Out of these, 38 are technology based financial inclusion projects while other 8 are credit driven projects. Project Namaskar outreaching villages: For higher mobilization of CASA deposits, the bank has launched an ambitious Project Namaskar under which 1 lakh touch points will be established in un-banked villages by 2013 to extend the bank s outreach, thereby creating a large customer base. Valuation Model: PNB continues to differentiate itself from other PSBs through stronger business growth and superior NIM management. We expect the stock to continue to outperform the Bankex in the medium term. We have valued the company on the basis of Price to its adjusted book value and we value it at a premium to its peers, assigning it a multiple of 1.8x. At CMP of Rs.983 PNB trades at PE of 6.9x of FY11E and 5.9x of FY12E with EPS of Rs and Rs respectively. We re-initiate coverage with a buy rating on the stock with a target price of Rs 1173 (1.8x of ABV FY12E). 3

4 PNB has lowest share of International loan book.. Key investment Criteria: Lowest share of international book: Low-margin international business forms a significantly smaller proportion of loan book for PNB at just 2-3% as compared to 15-25% for most its PSU peers. With domestic margins of more than 3.0% and international margins for most players in the % range, lower share of international loan book also aids higher margins for PNB Proportion of Investment book in AFS PNB CANARA SBI BOB UNION BOI Low AFS category exposure reduces the bond yield risk. PNB has been constantly working on increasing its global scale by rapidly expanding its network abroad.. Less Vulnerable to Bond yield: With pick up in credit growth and increase in the bond yields, treasury losses are expected. Although public sector banks are more exposed to treasury losses on rising yields, PNB s profitability is less sensitive to bond yields relative to its peers given the lower proportion of its investment book in the AFS category. PNB holds close to 17% of its investments under AFS category, which significantly reduces earnings risks and volatility in earnings. Increasing its global scale and footprint: PNB has always differentiated its global strategy by focusing on retail markets rather than corporate finance, which has been the prime focus of its peers. PNB is already in the process of acquiring more than 63% stake with management control in Dana bank in Kazakhstan. Also PNBs branch at DIFC (Dubai) is already operational since December 09. To further increase its global presence, the bank has started the process of setting up a subsidiary at Vancouver (Canada), setting up of representative offices in Sydney, (Australia) and up-gradation of Representative Office at Shanghai (China) and Norway to a branch. The bank recently opened its fifth branch in the UK & plans to open another 2 branches. 100% 80% 60% 40% 20% NPA Coverage Comfortable NPA coverage assures good stability for long term: The coverage ratio reported by the bank stands at 81.17% (inc. technical w/offs) as of end March, 2010, thereby withstanding any quality pressure in the foreseeable future. Currently it maintains the highest coverage ratio among the PSU banks. The net NPA ratio for PNB stands at 0.53% for FY10 as compared to the 0.17% reported for FY09. 0% PNB BOB UNION BOI SBI 4

5 4.20% 4.00% 3.80% 3.60% 3.40% 3.20% 3.00% F1Q08 F2Q08 F3Q08 Net Interest Margin F4Q08 F1Q09 F2Q09 F3Q09 PNB s Capital Adequacy Ratio is 14.16%, which is the best among its peers PNB s return ratios have been highest among the PSU banks F4Q09 F1Q10 F2Q10 F3Q10 F4Q10 Improvement in NIM leading to higher NII: PNBs net interest margin increased marginally by 5bps making it 3.57% for the fiscal year as compared to 3.52% reported for the fiscal year With more mobilization of CASA deposits in the untapped and unbanked rural areas coupled with significant reduction in cost of deposits, will increase the Interest income in near future. The bank continues to invest in expansion of its branch network to grow its CASA base and to create an integrated distribution network for both asset and liability products. However it is expected that margins might fall in 1QFY11 due to the impact of CRR hike, and shifting of savings deposits calculation to average daily basis impacting the margin by around 10bps in the first quarter. Adequately capitalized to sustain growth: PNB s capital adequacy was reported at 14.16% for FY10, which is much higher than the RBI stipulated norm of 9%. This acts as a good cushion for bank and it need not go for any additional capital. The bank s capital adequacy ratio is strong which is aided by strong internal accruals and a judicious mix of Tier I and Tier II capital. Strong Capital adequacy position of the bank indicates that the depositors are well protected. Superior return ratios as compared to peers: PNB s return ratios have been highest among the PSU banks, and we expect the higher return ratios to be sustained. PNB s ROE of ~24% is best in the industry, with peer ROEs at 16-20%. Superior margins due to a solid deposit franchise coupled with significant improvement in core fee income (laggard till FY05) and low international exposure would result in ROA being 20-30bp higher than its peers. We expect the bank to post superior ROE at 24% for FY12E and thus remain premium to its peers. C/D ratio improves on higher growth in advances: PNB s C/D ratio expanded ~100bps y-o-y to 74.8% as compared to 73.75% in FY09. The rise in CD ratio was mainly supported by the strong growth in advances. With credit growth expected to be around 21-22% in the coming fiscals, we believe that the C/D ratio will be maintained at the same level. 5

6 % 44% 42% 40% 38% 36% 34% 32% 30% BRANCHES NETWORK FY05 FY06 FY07 FY08 FY09 FY10 No. of Branches Q2FY08 Addition during Yr CASA proportion of total deposits Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY Q3FY10 Q4FY10 PNB has strongest liability franchise with 41% CASA ratio Good stronghold in Indo Gangetic Northern region: PNB is second largest public sector bank in India with its main focus on Indo-Gangetic belt. With the total asset base close to Rs 3 trillion, the bank is serving close to 5.6 crores valued customers and is expected to reach the target of 150 million by PNB has around 3700 branches (almost 74% of total network) in Indo-Gangetic belt, comprising 13 states of India, mainly in the agricultural area. Despite the high growth in term deposits in FY10, PNBs CASA ratio was maintained at 41% which is one of the best in the industry. Further the management expects to maintain CASA around same levels in the current fiscal. To achieve and maintain this level of CASA, PNB has started a pilot project in the un-banked villages called Project Namaskar. In addition, the bank has highest proportion of rural branches among its peers at around 45% of the overall network. Due to its presence in rural area the bank is able to garner low cost deposits which has supported the bank s margins. Also these rural branches entail high operating expenses and low productivity metrics for the bank but provide it stable, low-cost Retail Deposit franchise, not only high on savings accounts but also retail term deposits that are relatively cheaper than wholesale deposits. Agriculture lending leads to huge portfolio: Bank s management has constantly focused on providing agricultural advances, mainly on the back of the tie up with various sugar mills, dairy units, etc. Credit to agriculture increased to Rs 30,207 Crs as on March 31, Recording a y-o-y growth of 20.5%, this is higher than the national goal of 18%. Direct agriculture advances of the bank have shown robust growth of 25.6%, thereby forming a substantial 19.53% of ANBC exceeding the stipulated norm of 18%. PNB has issued 4.27 lakh Kisan Credit Cards during the year , taking the cumulative number of KCCs issued to lakh since its inception. Credit to the MSME sector recorded y-o-y growth of 27.4% reaching a level of Rs 35,034 Crs as at the end of March, PNB has adopted multi pronged strategy to disburse fresh agriculture loans of Rs 30,207 Crs during the fiscal year. 6

7 Key Investment concerns: I N V E N T U RE Loan Book Composition Agriculture Retail SME Large Corp Others Source: Company Agriculture lending exposes the bank to greater delinquency. Operating expenses might peak up from this point. 6% 5% 4% 3% 2% 1% 0% SBI Highest restructuring among peers BOB CANARA BOI UNION PNB High focus on retail, agriculture and SME book: High risk segments like SME and agriculture contributes approximately 35% of the advance book which have a higher risk of delinquency. Also these sectors are widely influenced by Governments decisions and are subject to various Government waivers. Currently, PNB is focusing on improving its retail book share from ~11% at present to ~25-30% by FY11-12, thereby increasing the asset quality risk for the bank. Moreover, PNB s customers are primarily from rural areas and un-favorable monsoons or drought may lead to higher delinquency for the bank. Sensitivity of earnings to asset quality: As high as 70% of the NPA of PNB relates to priority sector loans, this is on account of high exposure to agri-loan portfolio, this comprises of 16% of overall credit book. These factors expose bank to near term defaults, however the bank has superior provision coverage ratio to cover the loan loss. High Operating expenses: PNB s operating expenses as a percentage of average assets are marginally higher as compared to its peers. The high cost is associated by the huge branch network of more than 5000 branches. Bank s staff expenses are expected to increase as competition intensifies even in the semi-urban and rural areas, which in turn will require more employees (currently ~53000 employees). Further, the management expects to add 200 more branches to expand its branch network. We believe that costs would peak up over the next couple of years on the back of increased wage levels. Also with the loan book expansion and opening up of new branches, the expenses are expected to rise from the current levels. Concern on asset quality due to high restructuring: PNB s biggest concern is a sudden rise in the restructured advances. In FY10, PNB has added 2549 accounts in restructuring advances. Bank s outstanding restructured loan book has increased to Rs121b (~6.5% of loan book). Due to a sudden surge in restructured assets we expect the asset quality to further deteriorate from the current levels. However the bank s management has indicated that they would try to reduce the slippage ratio by aggressive monitoring and improving the recovery and would try to maintain gross NPA levels at less than 2%. 7

8 The bank has taken various initiatives like Factoring, forfeiting and trade finance to increase its core fee income as it is amongst the lowest in the industry Aggressive global expansion might expose the bank to foreign exchanges risks and might impact the NIMs.. Lower Other (Fee) Income as compared to its Peers: PNB s other income share to the total income is amongst the lowest in the industry. However to improve its core fee income, the bank has taken various initiatives like Factoring, forfeiting and trade finance, Merchant banking business, Insurance sales with LIC India and Oriental Insurance CO. Ltd. However, we still expect the other income share to remain lower than the peers as its main focus is in rural areas where there is lower finance literacy. Uncertainty regarding bond yields: There is an uncertainty regarding the Government s borrowing program which in return is impacting bond yields. We expect bond yields to remain high in the near term which will impact Other income of the bank. However, the impact for PNB will be the lowest as it has a lower proportion in the AFS portfolio. Global expansion might be expensive: The bank is growing rapidly on the international front and plans to continue its growth globally. Although it is a positive sign, there is a concern of forex losses that could be reported by the bank in the future quarters due to adverse fluctuation in currency. Further spreads in countries abroad may not be as healthy as in India and asset quality concerns could continue to weigh in overseas branches. 8

9 Banking sector is likely to see credit growth of % in the current fiscal.. NIMs expected to rise; coupled with acceleration in loan growth.. Gross NPAs for the banking system are likely to be 3.5 % for the 2011 fiscal. Banking Sector Overview: The Indian banking industry s strength comes from its huge deposit base, which is consistently growing. RBI has taken proactive measures to steadily improve banks balance sheet strength, and the demand in the economy for physical asset creation. The growth of banking in the coming years is likely to be more qualitative than quantitative. The banking sector is likely to see credit growth of % in the current fiscal, driven by demand from infrastructure, retail and working capital financing. Banks are expected to achieve a compounded growth rate of 22% in deposits. The growth of the banking sector is highly correlated with the overall growth in GDP of the country. With Prime Minister's Economic Advisory Council expecting India's GDP to grow from 7.2% in FY to 8.2% in FY and further to 9.0% in FY , (average GDP growth rate of 8.5%) growth in the infrastructure and agriculture sectors is expected to continue, thereby boosting credit growth and hence benefiting the banking industry. In addition, India Meteorological Department has forecasted that the rainfall for the country as a whole is likely to be normal this year, thus it is expected that the demand for agricultural credit would be higher and there would lesser defaults this fiscal. Even as the economy is firmly on the revival mode, rising inflationary expectations in the economy may derail the recovery process. We expect strong core operating performance by the Banking sector driven by robust loan growth, rising NIMs, strong rise in core fee income. Though interest rates are set to rise, lag in deposit re-pricing, rising credit-to-deposit ratio and higher yield on investments will likely boost margins. The gross non-performing assets for the banking system are likely to be 3.5 % for the 2011 fiscal. Sectors such as real estate, textiles and export-oriented small and medium enterprises are likely to contribute to the NPAs. Credit demand has gathered pace during the recent period on the back of improving investment and consumption demand in the economy as indicated by the strengthening industrial activity. Thus after a period of consolidation, it is expected that the Indian economy is well placed to grow rapidly again. With ample liquidity in the banking system, it is expected that the interest rate would remain benign. In our view, above factors are favorable for a higher credit demand in the economy. 9

10 Source: RBI, IGSL Research Liabilities to the Banking System Sep. 09 Oct. 09 Nov. 09 Dec. 09 Jan. 10 Feb. 10 Mar. 10 Time Borrowings from Banks Other Demand and Time Liabilities Source: RBI, IGSL Research Sep. 09 Aggregate Deposits Oct. 09 Nov. 09 Dec. 09 Jan. 10 Feb. 10 Mar. 10 Source: RBI, IGSL Research 10

11 CAR (%) Summary and Conclusions: The banking sector is likely to see credit growth of % in the current fiscal; we believe that PNB is set to return to growth path expecting about 21% credit growth in FY11. The bank expects credit growth to come from Agriculture, Retail, housing and education. Also with sustained investments in expansion of branch network will further enhance CASA ratio, which is expected to remain around 40-42% in FY11. The bank has the highest number of branches amongst all the nationalized banks and expects to add 200 more branches to its network. PNB has one of the highest NIMs in the industry and has superior return ratios as compared to most of its PSU peers. Strong core operating performance is likely to offset the higher NPA provisions and operating expenses in FY11. Bank s capital adequacy has dipped a bit in the past few quarters but it still seems to be adequately capitalized to sustain growth On the risk front, PNBs gross & net NPAs marginally rose to 1.71% & 0.53% from 1.6% & 0.17% y-o-y. The gross NPAs include INR 3.4 bn of agricultural advances eligible for debt relief due to non-payment of the share amount by the farmers by March 31, Bank s outstanding restructured loan book has increased to Rs121b (~6.5% of loan book). However the provision coverage ratio at the end of the quarter was 81.2% (inc. technical w/offs), higher than RBI s requirement of 70%. We expect the GNPA to be in the range of 2% till FY12E. PNB remains adequately capitalized for growth with an overall CAR at 14.2% and Tier-1 capital at 9.2%, which is one of the best among state-owned banks. Going forward PNB is expected to achieve above industry credit growth of 21-22%, along with healthy margins ~3.5% in FY11. However, the asset quality remains a concern for the bank. Thus it is expected that bank will continue to outperform with improved interest and non interest income and comparatively superior return ratios. 11

12 Index Comparison PNB has outperformed the Sensex and Bankex in recent market scenario.. Source: BSE 30.0 RETURN ON EQUITY 25.0 Return on Equity to remain in double digits in coming fiscals..and is best in class, with peer ROEs at around 15-20% FY08 FY09 FY10 FY11E FY12E 180 EARNINGS PER SHARE PNB has a rising trend of earnings per share on y-o-y basis, which depicts a healthy future growth FY08 FY09 FY10 FY11E FY12E 12

13 PNB s return on assets has inched up to ~1.5% in FY10 from 1.1% in FY08..and is expected to be around the same levels RETURN ON ASSETS FY08 FY09 FY10 FY11E FY12E Trend in CD ratio CD ratio has expanded by almost 200bps over the past few quarters 76% 74% 72% 70% 68% 66% 71.8% 66.1% 70.0% 71.8% 73.8% 72.1% 70.9% 72.8% 64% 62% 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 Trend in Non Interest income 13

14 Profit and Loss Statement Rs. Crs Particulars (Year end March) FY08 FY09 FY10 FY11E FY12E Interest Earned Interest expended Net interest income Other Income Net total income Payments to/provisions for Employees Other Expenses Total Operating Expenses Operating Profit before prov. & Cont Total Provisions Profit before Tax Provisions for Tax Net Profit

15 Balance Sheet Data Rs. Crs Particulars Year end - March FY08 FY09 FY10 FY11E FY12E Equity Capital Reserves and surplus Total Reserves exc. Revaluation reserves Shareholders Equity (Net-worth) Deposits Borrowings Other Liabilities and Provisions Total Capital and Liabilities Balances with RBI and banks Investments Advances Fixed and other assets Total Assets

16 Financial Valuation and Ratios: Operating Ratios FY08 FY09 FY10 FY11E FY12E Cost to Income Ratio (%) Net Interest Margins (%) PE(x) P/BV EPS BVPS Profitability ratios (%) FY08 FY09 FY10 FY11E FY12E ROE ROA Other income/net income Asset Liability Profile (%) FY08 FY09 FY10 FY11E FY12E Advances/Deposit ratio Investment/Deposit ratio Gross NPA to Advances Net NPA to Advances Provision Coverage Ratio Capital Adequacy Ratios (%) FY08 FY09 FY10 FY11E FY12E Tier I Tier II CAR (%) Growth ratios (%) FY08 FY09 FY10 FY11E FY12E Net interest income Advances Growth Deposits Growth Operating Expenses Net Profit

17 Peer Comparison Rs. Crs Balance Sheet PNB SBI BOB ICICI HDFC Axis Bank Capital Reserves Total Deposits Investments Advances Total Assets Profit and Loss PNB SBI BOB ICICI HDFC Axis Bank NII PAT Net NPA % CAR(%) Financial Ratios PNB SBI BOB ICICI HDFC Axis Bank EPS P/E(x) Book Value ROA (%) P/BV Credit - Deposit (%) Return on Equity

18 For any queries please feel free to contact our Institutional Research Team Names Designation Id. Contact Number Nagji Rita CMD - - SALES Ravinder Kasliwal Head Institutional Sales ravinder.kasliwal@inveturegrowth.com /66 Dealing Shiv Damani Institutional Dealer shiv.damani@inventuregrowth.com Vinit Rita Institutional Dealer vinit.rita@inventuregrowth.com /66 Rashda Ainapore Institutional Dealer rashda.ainapore@inventuregrowth.com /66 Puja Shah Institutional Dealer puja.shah@inventuregrowth.com /66 Research Denil Savla Research Analyst denil.savla@inventuregrowth.com * 581 Sheetal Nirmal Research Analyst sheetal.nirmal@inventuregorwth.com * 628 Pankti Shah Research Analyst pankti.shah@inventuregrowth.com * 583 Divya Kant Research Analyst divya.kant@inventuregrowth.com * 582 Anshuman Jain Research Analyst anshuman.jain@inventuregrowth.com * 579 Sanjeev Haria Research Analyst sanjeev.haria@inventuregrowth.com Sibayan Banerjee Technical Analyst sibayan.banerjee@inventuregrowth.com Ashok Patel Technical Analyst ashok.patel@inventuregrowth.com Madhu Patel Technical Analyst madhu.patel@inventuregrowth.com Disclaimer This Document has been prepared by Inventure Growth & Securities Ltd. The information, analysis and estimates contained herein are based on Inventure s assessment and have been obtained from sources believed to be reliable. Neither Inventure Growth & Securities Ltd nor any of its employees or associates accepts any liability whatsoever direct or indirect that may arise from the use of information herein and shall not be responsible for its completeness and accuracy. It is not an offer to sell or a solicitation to buy securities. This document is for circulation only Visit us at Please send your Feed Back to igslresearch@inventuregrowth.com Inventure Growth & Securities Ltd Corporate Office: - Viraj Tower, 2 nd Floor, Near Landmark, Western Express Highway, Andheri East, Mumbai Tel.: , Fax: