We remain underweight on State Bank of India (SBI) as weak balance sheet and low profitability imply continued dilution ahead. In our view, revenue progression (loan growth plus fees) is likely to be tepid given slowdown in economic growth. Asset quality (9.1% impaired loans ratio and 14% infrastructure exposure) will likely remain under pressure, given peak lending rates and slowing growth.
Even after capital raising (9% dilution), FY14 consolidated CET tier 1 at 9.5% (by our estimate) is the lowest among large Asian banks. Further, high impaired loans (9.1%) with low coverage (45%) will keep internal capital generation low. Against the backdrop of Basel III and D-SIB norms, this could lead to continued cash calls.
We have reduced our price target to Rs 1,150 from Rs 1,225, implying 23% downside from current levels. We value SBI using a probability-weighted sum-of-the-parts method. We assign probability weightings of 50% to our base case, 45% to our bear case (reflecting the high probability of a deep and protracted slowdown and also to general conditions of balance sheets at the SOE banks), and 5% to our bull case (reflecting our low expectations of a V-shaped economic rebound).
SBI's Q3FY14 PAT fell 35% y-o-y. Higher credit costs led core operating profit to fall 20% y-o-y. Impaired loan formation was above our estimate at 1.4% of loans. NII was in line. Fees/FX income picked up, but unlikely to be sustained. PPoP margin improved, but sustaining it will be tough. This was driven by higher fees and volatile FX income Ė unlikely to be sustained, as seen at other banks.