Our discount rate declines from 14.8% to 14.4% as we decrease the risk-free rate to 7.8% from 8% (in line with estimated 10-year government bond yields).We arrive at our new target price using a three-stage residual-income valuation method that assumes 14.5% CAGR for interest-earning assets over FY12-17f, 7.8% CAGR over FY17-25f and a terminal growth rate of 4%.
In addition, we expect average ROE of 18.7% over FY12-17f, 13.4% over FY18-FY25f and a 9.5% terminal value ROE, and discount rates ranging from 14.4% (current cost of equity) for FY12-17f, 12.3% for FY18-25f and a 10% terminal rate. At our target price, PNB should trade at 1.1x our FY14f ABV of R1,002 and 6.3x our FY14f EPS of R175 for an ROE of 18.7% for FY14f.
We believe the stock is still relatively cheap versus peers. From a relative perspective as well, the premium of SBI to PNB is at a historic high and we expect this to narrow. After a severe increase in non-performing loans over the past four quarters, we expect asset quality deterioration to moderate going into FY14F. GNPLs for the bank have increased from R5,150 crore to R14,000 crore, with the GNPL ratio inching up from 2.1% in Q2FY12 to 4.7% in Q2FY13.
During the same period, the bank's restructured book rose significantly from R19,600 crore to R27,900 crore.
We expect PNBs asset quality situation to stabilise going into FY14f on expected interest rate cuts. We are budgeting in a quarterly run-rate of R2,500 crore in delinquencies for FY14f versus R3,000 crore in FY13f.
We expect recoveries and upgrades of R4,600 crore for FY14f against R4,100 crore in FY13f. We expect the GNPL ratio to stay flat at current levels of 4.6% and, hence, we expect the bank to clock in LLPs of 99 bps in FY14f, down from 118 bps in FY13f. The total impaired loan book for PNB (GNPL plus restructured loans) was 14.1% at the end of Q2FY13. We believe that PNB should be a big beneficiary of an expected turnaround in the asset quality profile of the Indian banking sector.