Union Bank of India: Buy

M.V. S. Santosh Kumar

Investors can consider buying the Union Bank of India stock with an investment horizon of more than a year. A low price-to-book value, with a high return on equity, indicates the stock to be relatively undervalued. Investors should, however, be willing to wait out the current period of tight liquidity and uncertain macro environment.

Given the volatility in the markets, investors are advised to accumulate the stock gradually during dips. Union Bank of India at current market price of Rs 145, trades at 5.4times its estimated FY-09 earnings and 1.26 times its June 30 book value, at a discount to most PSU banks, except Syndicate Bank and Allahabad Bank.

Strong return ratios (return on equity of 26.8 per cent and return on assets of 1.26 per cent) place the bank among the best in the PSU space in terms of profitability.

This apart, a strong branch network, which is 100 per cent CBS-enabled, a diversified loan book with a tilt towards corporate advances, a high NPA provision cover and higher efficiencies (cost-income of 40 per cent) are also investment positives.

Business

Union Bank’s advances mix features a 16.6 per cent exposure to SMEs, 21 per cent to retail clients, 14 per cent to agriculture, while the rest of the portfolio is contributed by corporate advances. The bank is the first nationalised bank to be 100 per cent Core Banking Solutions (CBS) enabled. This enables the bank to receive fee income by way of electronic fund transfers (from NEFT, RTGS) and reduce processing time and expenses. The bank expects 25 per cent of its transactions to be done electronically by March 2009.

Over the past five years, the bank’s balance-sheet and advances have grown at a 20.8 per cent and 26.5 per cent Compounded Annual Growth Rate (CAGR) respectively.

During the June quarter, the advances and deposits grew at 19 per cent and 23 per cent year-on-year, driven by SME advances growth. Net profits grew marginally at 1.51 per cent owing to higher provisioning and employee costs, both of which will continue to be a challenge in the quarters ahead.

Union Bank has seen high cost deposits reduced to 15 per cent in the quarter, from 21 per cent; but this ratio could show some increase this quarter because of the ongoing liquidity crunch. The bank has been successful in improving its CASA by 1.5 percentage points to 34.76 per cent.

The advances growth did not translate into growth in net interest income due to increased cost of funds and falling yields on funds due to 25 bps cut in PLR in February. The net interest margin stood at 2.63 per cent for the quarter. Operating profits were hit by shrinking non-interest income and higher operating expenses. Cost-income ratio has increased from 38 per cent to 40 per cent, still among the lowest in the industry. The bank had taken a one-time hit on the additional AS-15 employee provisions last year. Going forward, provisions on this count will not be necessary, placing it in a better position than peers, in terms of earnings. Lower provisioning on the investment portfolios on softening bond yields, may also see a partial writeback of the Rs 330 crore it provided last quarter.

Though gross NPA to advances stands at 2.06 per cent, the provision coverage of 93 per cent has helped the bank maintain its net NPA to advances at 0.15 per cent.

The Government stake in the bank is 55.4 per cent, which will make it challenging for the bank to raise additional capital in the form of equity; but head-room exists for raising capital up to Rs 3,500 crore in the form of tier-1 bonds, perpetual cumulative bonds and so on.

The bank’s capital adequacy ratio is 11.28 per cent according to Basel-II. Focussed lending to different sectors by setting up specialised branches helped the bank in healthy disbursement of the loans.

Outlook

Among PSU banks, Union Bank of India has a first-mover advantage in technology adoption. The bank’s re-branding exercise at Rs 75 crore to target the younger generation may also help; the roll-out of more than 100 branches this fiscal may also aid in attracting low-cost deposits. A recent entry into wealth management services has the potential to boost ‘other income’. Though an entry into mutual funds and insurance businesses is also on the cards, these may be challenging in the current environment.

The bank’s ‘other income’ covers only 53 per cent of total expenses. Leveraging on branch expansion and international presence can boost its ‘other income’; with 55 per cent of the branches in rural and semi-urban areas where there is lower competition, there is greater scope for sourcing low-cost deposits.

The bank expects to grow deposits and advances at 23 per cent and 22 per cent respectively over the next year, but earnings growth may be muted because of tighter liquidity, leading to high cost of funds. NIMs may also be flat, though the bank expects them to improve to 2.85 per cent by end-FY-09 as it has increased PLR by 125 bps.

The bank intends to improve asset quality by bringing GNPA/advances down to less than 2 per cent, but the prevailing interest scenario may lead to higher delinquencies.

With the CRR cut of 150 bps, the bank may have around Rs 1,500 crore additional funds, which were yielding no returns; this may helpin reducing the burgeoning cost of funds.