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Suresh Krishnamurthy

Mr S.S. Kohli, Chairman and Managing Director.

IN<150>VESTMENT can be considered in Punjab National Bank at Rs 390. The offer price is at a discount of about 10 per cent to the prevailing market price.

At Rs 390, the higher end of the price band set for the book-built offer, the stock of Punjab National Bank is not under-valued. It fully factors in growth expectations and maintenance of return on net worth of 15-20 per cent. The stock also enjoys valuations richer than that of the SBI, a bank that is larger and more diversified. If investors are, thus, to redeem their investments with reasonable profits, it is entirely predicated on the banking growth story continuing.

Given that the growth impulses in the economy are stronger than ever before, the probability of profit growth being sustained by banks is high. In addition, the Punjab National Bank stock is, probably, the best play on the growth in such core banking profitability.

The sensitivity of the stock price to such adverse developments as decline in spreads accompanied by low volume growth or a decline in asset quality are, however, high. These risks are accentuated for investors looking to remaining invested for the short term.

Superior scorecard

Among public sector banks, the Punjab National Bank stock is the most richly valued. The reasons are not far to seek. After the SBI and ICICI, it is the largest bank with total assets of about Rs 1,10,000 crore.

Despite that size, its operating and profitability parameters are among the best. Business growth has also been better than that of the industry over a substantially long period.

The proportion of bad loans was at 0.3 per cent for the bank at end-December 2004. This is lower than that of a number of private sector banks such as ICICI and UTI Bank. PNB's spread — difference between the rate at which funds are lent and borrowed — is amongthe higher ones in the banking industry. Nearly 45 per cent of its deposits are of the low-cost variety and the bank is consequently cost-competitive.

For such a large bank, it has also made rapid strides on the technology front. It has inter-connected 943 of its 4,400 branches and expects to raise the number to 1,500 by end-March 2006.

Only in the case of two parameters — expense ratio and share of fee incomes in revenues — can the bank's performance be rated average. There is ample scope for improvement in both.

Growth and risks

Its superior statistical profile will allow PNB to take better advantage of the growth opportunities and translate it into profit growth.

The non-food credit disbursement of the banking sector is expected to rise by 20 per cent in the year ended March 2005. The credit growth the following year is also expected to be robust.

Punjab National Bank is also less well-represented in the growing, but intensely competitive, West and South regions. Its size and cost-competitiveness, however, could fetch it market shares in these regions.

The bank's size would also help in absorbing risks. Indian banks have been asked to step up allocation to the agriculture has been good. The size of the bank should help in diversifying its agriculture lending and, thus, reducing risks. Incidentally, this bank's experience with agriculture is a cause for comfort. Gross bad loans for agriculture were about 4.4 per cent compared to 7.7 per cent for all loans put together.

A looming risk is that of a merger with the beleaguered development financial institution, IFCI. Punjab National Bank may be asked to take over the bad loans of IFCI also in a merger. If this happens, the size of the bank and its present status of virtually zero bad loans will come in handy. Besides, the bank may be promised government grants and also reap tax benefits from such a merger.

With the book-built offer set to sail through at the upper end of the price band of Rs 390, the net worth of the bank after the offer will rise to nearly Rs 8,000 crore by end-March 2005.

If profits for the coming few years have to rise by about 10 per cent per annum, then the return on the net worth would need to be 20 per cent next year and between 15 and 20 per cent the following years. In an environment of all-round industrial growth, all this is achievable. This could translate into a return-to-investor of 12-15 per cent per annum for a holding period of three-five years. Risks that could scuttle such an outcome lies in a decline in commodity prices accompanied by a slump in industrial growth.

The Punjab National Bank stock is, however, not the premier pick in the banking sector. That status should go to SBI. At the current market price, the PNB stock trades at a price-to-book ratio of about 1.9 times. This is higher than that for SBI. Considering the core banking strengths of Punjab National Bank, the valuation appears justified. SBI's consolidated profits ( including contributions from asset management and insurance) are, however, growing at a more rapid pace.

For this reason alone, SBI should be the top pick. PNB would be a good complement as an exposure to the banking sector in any portfolio.

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