As the Indian economy recovers, consumption has started picking up and demand for credit is set to get better in the next fiscal.
This, along with rising interest rate scenario, would mean the net interest income for banks would grow faster.
Dena Bank, a midsized public sector bank, with its low-cost deposits, expected strong loan growth and proposed capital infusion by the government, would benefit from this economic recovery.
Business: Dena Bank, started in 1938, has close to 1,200 branches across the nation with total assets of Rs 50,610 crore.
Headquartered in Mumbai, it has significant presence in western states, including Maharashtra and Gujarat.
The bank has close to 38% branches in rural areas with branches in semi-urban, urban and metro cities constituting 19%, 18% and 25%, respectively, of its network.
Dena Bank has a significantly high proportion of low-cost deposits with CASA (current and savings account) ratio being at 36.9% as on September 30, 2009. This high CASA ratio is primarily due to its strong branch network.
Dena Bank has seen good loan growth of 23% in the first half of this fiscal and plans to end this year with around 20% growth.
The bank has well diversified exposure to various segments with around 35% lending to corporates, 19% to SME, 16% to retail and 30% to agriculture.
Dena Bank’s capital adequacy ratio (CAR), which is a measure of a bank’s strength, was below optimum level at 13.26% at the end of Q2, FY10.
The bank is due to receive equity infusion of Rs 1,200 crore from
the government over the next 3 years, with Rs 600 crore coming this year in the form of preferential equity and preference shares.
After this, the government’s stake would go up from 51% to 59% which would make it easy for the bank to raise capital from markets on its own.
This capital infusion would improve Dena Bank’s tier-1 capital from 8.1% as on Q2, FY10 to more than 9.5% in fiscal 2011.
Tier-1 capital is the core measure of a bank’s financial strength and consists primarily of equity capital and disclosed reserves.
Dena Bank’s provision coverage ratio (the extent of funds a lender needs to keep aside to cover its loan losses or non-performing assets) currently is at a low 38% on account of higher slippages and an aggressive write-off policy.
However, if technical write-offs are also considered while computing coverage ratio as per recent RBI clarifications, Dena Bank will not have to set aside further funds to cover its NPAs.
Investment rationale: The domestic economy is reviving fast and there has been a pick-up in demand for loans for homes, automobiles and other purposes.
As demand improves, capital expenditure by private sector companies will also pick up, leading to better loan growth.
The increase in key interest rates by the Reserve Bank of India would also help increase Dena’s interest income.
The bank reported net interest margin (NIM) at 2.28% in Q2FY09 and expects to close the fiscal at around same figure, less than last year’s figure. This is primarily because of deployment of excess funds into liquid mutual funds, income from which is classified as other income.
Dena Bank’s NIM is expected to improve going forward on account of low-cost funds. The bank plans to improve CASA ratio by 100 bps as it is looking at 20% growth in CASA deposits by the fiscal end.
Also, its considerable deposits are scheduled for downward re-pricing in the coming quarters, which would reduce the cost of deposits further.
The bank would also benefit from its increased focus on retail and SME sectors where the yields are much higher than in corporate lending.
Going forward, recoveries from written-off assets would improve non-interest income as the economic condition improves. Dena Bank is also considering sale of non-performing assets worth Rs 300 crore, which would further add to profitability.
The potential consolidation among public sector banks in future would be a further trigger for the stock. Dena Bank, with a nation-wide presence and large low-cost deposits portfolio, would be an attractive acquisition target.
Concerns: The key concern for the bank is its asset quality, which has been a problem in the past. Though the current asset quality
is stable, it may deteriorate on account of aggressive loan growth and in case the economic conditions worsen.
Dena Bank is subject to stiff competition from large private banks, which may take away its business share and eat into its strong
CASA deposits segment.
Any delay in capital infusion by the government would impact its loan growth plans.
Valuations: The loan growth is expected to be at 18% over FY09-FY11E and earnings are expected to grow at 14% over the same period.
At current market price of Rs 87.5, the stock trades at 5.24x & 4.56x its expected earnings per share in FY10E and FY11E.
On account of its strong low-cost deposits, large presence, potential capital infusion by government and improving credit growth scenario, investors can look at the stock from medium- to-long-term perspective.
Disclaimer: The writer does not hold any shares in the company
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