'Neutral' ratings on State Bank Of India shares, Pace of debt recast slows down: J P Morgan

Updated: Feb 24 2014, 20:54pm hrs
The State Bank of India reported a profit after tax of Rs 22.3 bn (down 34% year-on-year, 8%Asset quality: Gross delinquencies remained elevated and stood at 4% vs. 3% in Q2. Recovery+ upgrades were also muted at 17% vs. 25% in Q2. However, higher write-offs led to lower headline gross NPLs of 5.74% (up only 9bp quarter-on-quarter). The fresh slippages mainly emanated from the mid-corporate and SME segments, which are the most vulnerable in the current environment. Credit costs also remained higher, at 1.25% vs. 1.12% in Q2. Management stated that the asset quality will improve with a two-quarter lag once the economy turns around. We expect asset quality stress to continue in the medium term, given the weak macro.

C/Income: C/Income (cost-to-income) remained higher at 55%, as opex (operating expense) grew 31% while revenue grew just 14% y-o-y. Wage costs were higher at 35% y-o-y due mainly to: (i) higher pension provision on account of revisions in the mortality table. The management stated that the full impact of pension costs is likely to crystalise by March-end once the actuarial valuation is done. We believe there could be some benefit on pension costs due to higher rates; and (ii) higher wage hike provisions, pending the final settlement. Overheads costs were also higher, at 26% y-o-y. The management mentioned that it is an area of concern and significant steps are taken to bring it down.

Margins: Domestic margins remained resilient, at 3.49% (up2bp q-o-q). YOA (yield on assets) were up 8bp q-o-q, at 10.4%, due mainly to a base rate hike of 20bp in Nov-13. Despite higher rates, the funding costs were up just 2bp q-o-q, to 6.4%. The management expects margins to remain stable at the current levels, in line with our expectations, given the recent cap hike. Savings account growth was impressive at 5% y-o-y, while CASA (current account and savings account) remained strong at 43.9%.

Loan growth: Domestic loan growth remained strong at 15% y-o-y and 2% q-o-q. Retail loan growth was strong at 16% y-o-y and 3% q-o-q, driven by robust growth in home and auto loans, which has been the focus area for the bank. Given the stress in the economy, the management is cautious in the mid-corporate and SME segments. The mid-corporate segment was down sequentially, whereas SME book grew by just 1% q-o-q. The growth in infra book was robust, at 28% y-o-y; however, it was driven by mainly incremental growth to high-quality state-owned utilities and discoms.

Investment thesis: We maintain our Neutral rating on the stock as:

Asset quality challenges should persist. We expect elevated levels of delinquencies in the medium term, from both NPLs and the restructured portfolio.

We expect margins to remain stable in the medium term despite higher rates, driven by strong liability franchisee and benefits of the cap raise.

SBI has valuation support, but the near-term trajectory looks quite challenged. The pressure on asset quality continues to concern us.

Valuation: Our Sept-14 PT (price target) of Rs 1,800 is based on a Gordon growth model with a normalised ROE (return on equity) of 15%, second-stage growth of 12% and R274/share for the insurance and subsidiaries business.

Risks: Key risks to our Neutral rating include: (i) slower economic growth, leading to higher delinquencies; (ii) rising restructuring, leading to higher NPAs; and (iii) higher loan growth, which could positively impact revenue.