Canara Bank?s stock has outperformed Bank Nifty by 48% and the Nifty index by 63% over the past one year. Cost of funds will likely go up for the bank, in line with our sector view, but we expect better yields on its infrastructure book to cushion margins. We downgrade the stock to Hold from Buy, but the target price of Rs 746 is unchanged.
Canara Bank?s net interest margins (NIMs) have consistently improved QoQ (quarter-on-quarter) in the recent past, rising to 3.16% (+50 basis points YoY) in H1FY11. This was driven partly by the repricing of bulk deposits during a period of surplus liquidity in the system. The low-cost deposits (CASA?current accounts and savings accounts) grew 23% YoY, in line with total deposit growth, and thereby the CASA ratio remained largely stable at about 29%. However, the 12-month certificate of deposit rate is now 150-175 bp higher than the comparable one-year term deposit rates being offered by banks.
Infrastructure loans grew 63% YoY at Canara Bank to Rs 395 bn and constituted 22% of its loan book as of September 2010. This appears high compared to infrastructure lending?s share of 14.7% in the overall industry loan mix. On balance, we believe the better yield on the infrastructure book will help offset the rise in cost of funds. Thus, we expect NIMs to be largely stable, going forward. Our estimates factor in largely stable NIMs of 2.8-2.9% over FY11-13. If the NIM falls 10 bp, the impact on pre-provision operating profit will be 4.4% in FY12, based on our estimates.
Asset quality appears to be largely stable at Canara Bank with 6.2% in stressed loans as of September 2010 (1.5% GNPLs gross non-performing loans + 4.7% restructured loans). The consistently high cash recovery from bad loans (classified as NPLs) provides comfort on asset quality. Cash recovery as a share of opening gross NPLs was 73% in FY10 and about 100% in FY09.
Stock price performance leads us to downgrade the share to Hold. We keep our earnings estimates unchanged but downgrade to Hold as we believe the stock is trading close to fair value. At our target price, the stock would trade at 1.8x (times) FY12e adjusted BV (book value) and 7.2x FY12e earnings.
Canara Bank’s key strengths include a vast network in the southern part of India. The government holds a majority stake at 73.2%, leaving room for equity dilution (current regulations require a minimum government holding of 51%).
?RBS