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INVESTMENTS can be considered in the stock of City Union Bank. It is a stock with market capitalisation of about Rs 150 crore and, therefore, risks involved can be considered higher.

The stock, however, holds the potential to deliver returns that would adequately compensate the risk involved primarily because of the low valuation relative to other banking sector stocks. The stock is trading at a price to earnings multiple of less than three times its earnings. The stock is also trading at a dividend yield of 7.8 per cent excluding the one-time special dividend of 20 per cent.

City Union Bank is one of the smallest listed banks in the country. It has a branch network of about 125 branches, most of which are located in Tamil Nadu. In terms of networking with automated teller machines, the bank has not made much progress, with only about six on-site ATMs. This has not affected the bank's growth in the past two years.

Its low-cost deposit base rose by about 18 per cent per annum in the past two years, which is in line with the average for the banking industry. It also sports one of the lowest cost-to-income ratios in the country suggesting that the lack of strong ATM networking is not being reflected in the form of higher costs.

Advances growth at an average of about 23 per cent in the past two years, is impressive. The return on net worth in the past five years has been about 20 per cent.

The major risk for investors in the stock stems from the high proportion of bad loans. It was about 50 per cent of net worth at the end of March 2004.

This would ensure that provisions for bad loans would continue to eat into profits. The high proportion of bad loans also constrains its ability to declare dividends. The valuation, however, factors these risks. Besides, it is also targeting to increase the number of ATMs.

The bank was also relatively less dependent on profit on sale of investments to power profit growth in the past two years. Consequently, the possibility of the bank delivering earnings growth necessary to generate capital appreciation is strong.

Suresh Krishnamurthy

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