Dena Bank: Buy

Investors with a three-year horizon can buy the stock of Dena Bank, a mid-cap public sector bank with presence mainly in Gujarat and Maharasthra.

The stock looks attractive from a long-term point of view as it trades at a discount to historical valuation, in spite of improving its operating metrics over the past few years.

The cost-to-income ratio of the bank declined from 51 per cent in 2008-09 to less than 40 per cent in the June 2012 quarter. At the same time, the bank managed to lend more funds rather than deploy it in government securities. Consequently, its margins improved during this period .

At the current price of Rs 106, the stock discounts its estimated FY-14 adjusted book by 0.71 times. This valuation is inline with other mid-sized public sector banks.

However, the bank, given its smaller loan book and presence in the western region of the country, which has high appetite for investments, should benefit from higher-than-industry growth in advances.

Also, better asset quality than its peers is an added advantage. The current low price-to-book value implies a jump in slippage of loans from restructured assets and a sharp fall in profitability, which are unlikely to happen.

One, the government has approved the restructuring of power distribution companies, which augurs well for Dena Bank.

While the yield on these assets might come down, post-restructuring, the risk of default will be mitigated. Additionally, conversion of 50 per cent of these loans into State government bonds would mean bank exposure limits freed up for more lending to the infrastructure sector.

Two, the bank’s loan book will continue to grow faster than the industry rate. This would translate into robust earnings growth. Any recovery in macro economic activity will enhance growth rates.

Between fiscals 2008 and 2012 , the earnings per share of the bank grew by an impressive 17 per cent compounded annually. Considering that the growth tempo is likely to maintained or even improved, Dena Bank’s price-to-earning multiple for FY-14 works out to an attractive 3.5 times.

Business growth

Strong growth in advances had led to improvement in Dena Bank’s market share. Its share in the loan market went up from 0.93 per cent in March 2008 to 1.11 per cent in March 2012.

The bank plans to focus more on high-yielding micro, small and medium enterprises (MSME), and retail loans for faster loan book growth.

As of June 2012, these two segments accounted for 26.4 per cent of the bank’s portfolio.

Dena Bank’s strong presence in Gujarat (one of the largest MSME hubs in the country) and Maharashtra, and in rural and semi-urban areas, augurs well.

The bank has also cut lending rates on SME and retail products to stay competitive and improve its share. Dena Bank has tied up with auto manufacturers to provide three-wheeler loans to their customers. The bank plans to add around 100 branches in the current fiscal.

The focus is on diversifying the branch network to under-banked areas and other States such as Tamil Nadu which have a large number of SMEs.

Availability of capital to fund its loan book growth may constrain Dena Bank, if it is not supported by the government (its promoter) from time to time.

Strong financials

The banks’s net interest margin (NIM) improved from 2.67 per cent to 3.17 per cent over the last five years ended March 2012.

This was a result of efficient fund deployment into higher-yielding loans. The credit-deposit ratio of the bank improved from 68 per cent in March 2008 to 74 per cent in June 2012.

The NIM declined to 3.06 per cent in the June quarter due to sharp rise in cost of funds. But the cost of funds may decline, given that the bank has cut deposit rates on select maturities.

With the majority of its deposits having maturity of less than a year, these may get re-priced at a lower rate. The cut in cash reserve ratio will also aid the margins of the bank.

On the flipside, while the bank’s cost-to-income ratio is currently low at 39.3 per cent, this is set to rise due to branch additions and higher employee costs following the impending wage hikes. Lower fee income proportion is another weak link for the bank.

Mitigating these risks are the bank’s plans to increase focus on retail product distribution to earn higher fee income, and expected robust business growth.

Strong asset quality

The gross NPA ratio of the bank, as of June 2012, was 1.8 per cent as compared to 3.35 per cent in the case of other public sector banks. The net NPA ratio was 1.01 per cent — one of the lowest in the banking sector.

The restructured loan proportion is also lower than most of the mid-sized banks. With most of the corporate debt restructuring completed, the risk of higher loan slippage may not be high. Around 83.5 per cent of the loan book is secured in nature.

While the MSME exposure might increase the risk for the loan book, the bank is participating in the Credit Guarantee Fund Trust for Small and Micro Enterprises. This reduces the risk of default on unsecured loans to this segment.

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