Over the past two to three years, public sector bank (PSB) stocks have been beaten down, due to weak earnings, and no let up in asset quality trouble.
Many are trading at less than book value, but these valuations can be misleading. This is because if the book value is adjusted for the bad loans and restructured assets, PSBs trade close to their book (adjusted) or more.
That said, investors with a two to three-year horizon can consider PSB stocks selectively, betting on relatively better performing banks or ones that offer scope for a turnaround. Bank of Baroda is one such bank.
It is among the better capitalised PSBs and has a strong domestic presence. The new MD and CEO is also expected to drive the bank’s growth over the next couple of years, with his focus on asset quality, rebalancing of portfolio and use of technology.
At the current price, the stock trades at 0.8 times its one-year forward book, below its long term (since 2007) historical average of one time. With the bank taking most of the pain on the asset quality front in the December quarter itself, there is scope for re-rating from the current levels.
Curious rally
The latest December quarter was one of the toughest for all banks, following the RBI’s asset quality review, known as the AQR. Banks were forced to recognise certain loans as bad under the AQR, which increased their provisioning substantially and hurt earnings. Bank of Baroda was no exception. It reported a huge loss of ₹3,342 crore in the December quarter due to sharp rise in provisioning for bad loans.
Fresh slippages increased from about ₹6,800 crore in the September quarter to about ₹15,600 crore in the December quarter. This has taken the bank’s gross non-performing assets, as a percentage of loans, to 9.6 per cent in the December quarter from 5.5 per cent in the September quarter. As a result, the provisioning for bad loans jumped over five-fold, dragging the bank’s earnings into the red.
But despite its poor performance, the stock rallied over 20 per cent after the results. This was due to several reasons.
All at once
One, the bank decided to recognise all its bad loans in the December quarter itself, thus taking the pain at one go. With this, the worst in terms of asset quality appears to be behind it, according to the management. In contrast, most other PSBs are likely to see sharp rise in slippages in the March quarter as well. This is a key positive that can play in favour of the stock.
Two, the management stated that it would not need capital in the next 18-24 months. Besides operational efficiencies, the bank also plans to monetise its non-core investments that can release about ₹2,500 crore (gain on sale from these investments).
Given that capital infusion at a price below the book value leads to dilution in book value and hurts investors, the bank being adequately capitalised is a key positive. Its Tier I capital stood at 9.5 per cent as of December 2015, against the mandated 7 per cent.
Finally, the four key focus areas emphasised by the new management in the September quarter — managing NPAs, rebalancing the portfolio, strengthening the organisation and building the digital platform — appear to be on track.
Rebalancing portfolio
Bank of Baroda’s loans declined 2.4 per cent as of December 2015, compared to the same period last year, as the bank is in the process of re-balancing its portfolio. It is reviewing the existing book and chalking out new strategies for growth.
For tackling NPAs, the bank has segmented loan accounts and allocated them to relationship managers. It is also in the process of preparing account-wise recovery plans.
The bank is also seeking advice from external consultants such as Crisil on a number of strategic issues. All these measures should yield results over the long run.
While the bank may face earnings pressure in the near term, it is likely to return to profitable growth over the next one to two years. The management expects the bank to return to its normal earnings in 2016-17, generating 8-12 per cent return on equity.