The Hindu Business Line : State Bank of India: Pare exposures

SHAREHOLDERS of State Bank of India (SBI) can contemplate booking profits partially. The stock's valuation now factors in successive years of ever higher dividends and modest growth in earnings, but not the risks that can affect the earnings performance

Quality income

SBI's net interest margin rose 10 per cent in the year ended March 2003. Net profits rose 28 per cent, mainly due to rising profits from treasury operations. The earnings also benefited from a reversal of a provision for Rs 812 crore made in the earlier years.

Like all banks, SBI has benefited from a reduction in the cost of deposits and a consequent improvement in spreads. However, if profit growth appears modest vis-à-vis other banks, it is mainly because SBI has chosen to enhance the provisions for non-performing assets. On a comparable basis, provisions rose 40 per cent, enhancing SBI's quality of reported income vis-à-vis other public sector banks.

While SBI has utilised one-time income to enhance provisions, it continues to suffer in comparison to other banks on a few parameters. The bank's cost of deposits is marginally higher than that of others such as Bank of Baroda or Canara Bank. Given SBI's strength and its positions as a banker for the Government, this is inexplicable. The ratio of non-performing assets at 4.50 per cent is also higher than that of other banks. SBI's score on return on assets, return on net worth and cost-to-income ratio are inferior too.

Robust growth

As regards 2003-04, SBI expects robust growth in the following year. Growth in advances is expected to be about 16 per cent. SBI expects to maintain its net interest margins, and profits are likely to continue flowing in from treasury operations.

SBI is also likely to benefit from the repricing of Resurgent India Bonds that are maturing this year. It is set to pay back Rs 26,000 crore and SBI hopes to retain 30-40 per cent. These were issued at relatively high interest and repricing them in line with prevailing rates will boost profitability.

If all this happens, the net profit growth is likely to be between 20 per cent and 25 per cent, depending on the amount to be provided for provisions. The performance of other public sector banks is showing up the impact of lower provisions. If SBI's provisioning requirements also decline, profit growth could be even stronger in 2003-04.

Valuation: Downside risks

The SBI stock now trades at about six times its earnings for the year ended March 2003. On the consolidated per share earnings, the multiple declines to 4.5, indicating that growth in cash flows required to support the valuation is quite low.

On the contrary, in terms of dividends, a 25 per cent growth in dividend per share is expected over the next five years to justify the current valuation.

Given the recent improvement in the industry fundamentals, such growth in dividends is possible. The size of its operations also offers SBI more avenues to grow.

However, risks such as a possible compression in spreads (difference between interest income and interest expense) exist. As high-coupon government securities mature and larger investments are made in government securities, offering yields of less than 6 per cent, the pressure on spreads will only increase. Such risks can curtail the growth rate in dividends.

This enhances the inherent downside risks to the stock. Shareholders can, therefore, consider booking profits partially at the ruling market price.

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