Corporation Bank’s operating profit grew by 61.9% y-o-y, driven by a 43.2% rise in the NII and a 69% rise in other income. However, comparing on a like-to-like basis, without the MTM gains, the operating profit grew by 31% y-o-y.
Despite healthy numbers, the impact of the business-cycle downturn has been evident in a moderate advances growth (3.2% sequentially), and a 75% y-o-y rise in delinquencies for 9M FY09.
We expect advances growth to average ~18% and ~16% for FY09 and FY10 respectively. This downward revision in our growth estimates is based on funding and delinquency concerns.
Funding concerns stem from a below average growth in deposits (2.7% q-o-q) and delinquency concerns emerge from the advances-mix.
The Bank’s advances-mix is dominated by large industries (30.6%), retail (20%), SMEs (10.4%) and agriculture (9.2%), which are likely to face near-term headwinds. Therefore, the Bank’s credit off-take is likely to remain moderate.
The Bank’s NIM compressed from 2.81% in Q3’08 to 2.53% presently. This, in our view, was on account of higher cost of borrowing.
For FY09–10, we expect margins to range between 2.3% and 2.4%, after accounting for a stable spread between yield on advances and cost of deposits, and a higher cost of borrowing.
We have assumed almost stable spreads based on the reduction in retail lending and deposit rates, (twice in the past two months).
Although the reduction is slightly higher on the lending-rate side than on the deposits rate end, we expect that the relatively higher rates charged on the wholesale-lending side are likely to maintain a reasonable stability in spreads.
We have valued the Bank using Discounted Equity Cash Flow (DECF) model where we have applied a cost of equity of 15.42% (calculated using CAPM) and an estimated terminal growth rate of 8.08%.
This results a fair value estimate of Rs182, which implies an upside of 11% over the current market price of Rs164.3.
We have tempered our fair value estimate downwards based on revised assumptions for credit quality and business-growth, having retained those for margins.
Moreover, our fair-value estimate is in line with the book value per share, adjusted for per share delinquencies (based on our estimates). At the end of the third quarter, the BVPS stood at Rs338.87.
Removing the potential delinquencies from this yields Rs294. Adjusting this for the impact of an anticipated slowdown in growth (terminal growth rate of 8.08% vis-à-vis cost of equity of 15.42%) by applying a long-term P/B multiple of 0.61x, we arrive at Rs176, close to our fair value estimate of Rs182.
Therefore, on grounds of potential deterioration in asset quality and growth concerns, we downgrade our rating to HOLD.