Wednesday, May 19, 2010

Sell Indian Overseas Bank (IOB) on Higher Levels: Indian Stock Market Tips

This was the third straight quarter, in which the bank’s profit fell on an year-on-year basis. Stock analysis published in ET investor's guide recommends to sell stock.

Year 2010 was a tough time for Indian Overseas Bank (IOB). And the latest results for the March 2010 quarter too did not provide any respite for the bank.

For the investors of IOB, this is a bad news as the bank was known for being a stable player earlier. In the first nine fiscal years of the current decade, the bank’s loan-book grew by an average rate of 23% per year. Similarly, net non-performing assets (NPA) formed an average 0.9% of net advances from FY05-09. Its average net interest margin (NIM) stood at 3.8% in the first nine years of this decade. NIM is a measure of spread between lending rate and deposit rate. In a nutshell, IOB was one of the banks that had maintained a steady rate of growth while maintaining a good check on the quality of its operations. However, the bank was unable to continue the good run in FY10.

The bank’s NPA kept on rising throughout the year. At the beginning of FY10, its NPA stood at 1.3%, which rose to touch 2.5% at the end of the year. In contrast, most of the other banks improved their asset quality during the year, thanks to improved economic condition. Moreover, at current levels, its NPAs are one of the highest in the banking industry.

When a bank’s NPA rise, its business growth takes a back seat. This is because in such a situation bank has to first take stock of its worsening asset quality. The same thing has happened to IOB as well. The advances growth has fallen from 24% in FY09 to 6.6% in FY10.

At a time, when its NPA are much higher than its peers, its provision coverage is much lesser. The Reserve Bank of India (RBI) had advised banks to maintain a minimum provision coverage ratio of 70%. At present, its coverage ratio at 54% is well short of the minimum advised by RBI. This shows that the bank will have to provide more in the coming quarters. This will affect its profit growth adversely going forward.

Besides, the bank’s operating expenses kept on increasing even though its business growth was lower. Its expenses grew by 31% in FY10, which has led to a substantial jump in its cost income from 43.5% in previous year to 57.2% in FY10.

The only parameter on which the bank’s performance is satisfactory is the share of low-cost current account and savings account (CASA) deposits. The share of such deposits improved from 30.3% in FY09 to 32.6% in FY10. In lines with industry, the bank managed to improve its CASA share. Moreover, its CASA share is as per industry’s standards. It’s NIM stood at 2.7%, which is a little lower than its own records. However, given the industry benchmark of 3%, its
NIM seems to be satisfactory.

The bank’s stock is trading at close to 7 times its earnings. More importantly, it is trading much below its book value. Its stock price is Rs 92 per share, while the book value stands at Rs 112 per share. So it is one of the few banking stocks, which are trading at a discount to their book value. But it doesn’t mean that investors should take exposure to it for the simple reason that its NPAs are high. It will take six months to a year for the bank to repair its asset quality.

Till then, its profitability will be affected due to slow business growth and high provisions. It makes sense for investors to sell stock at the moment because no upward movement is expected in a year’s time.