The Hindu Business Line : Yes Bank: Buy

FRESH investments in the Yes Bank stock can be considered. Since its listing in July 2005, the stock has appreciated by 43 per cent. The valuation is still attractive considering the growth prospects for a small bank with access to resources such as itself.

Experienced bankers — Mr Rana Kapoor and Mr Ashok Kapur — have promoted Yes Bank. Other major investors include Rabobank, Citigroup Venture Capital, Chrys Capital and AIF Capital. Foreign institutional investors hold a 11 per cent stake in the company.The bank proposes to increase the limit for FII investments to 49 per cent from 24 per cent.

Scaling up

Yes Bank has been able to access capital at attractive rates. Its next challenge was to scale up the business. In the first six months of FY 2006, its advances and deposits have risen by about 70 per cent. Even with the advances portfolio growing to nearly Rs 1,400 crore, Yes Bank has been able to maintain a clean record — there are no bad loans. Return on assets was a healthy 3 per cent with net interest margin also staying well above 3 per cent.

This performance reinforces the belief that private banks with access to capital and technology can gain market share and scale up at a rapid pace. Yes Bank is following in the footsteps of banks such as HDFC, UTI and Kotak Mahindra that started small and with institutional support. While Yes Bank entered late, the credentials of the team behind the effort is promising. The performance in the first half of FY 2006 is also encouraging in this regard. Besides, the growth prospects for India's financial services segment remains bright.

Notwithstanding the growth seen in the first half, there is still considerable scope for Yes Bank to scale up its business profitably. The capital adequacy ratio is a high 27 per cent. This means that Yes Bank has enough capital to grow its business without having to expand its equity base.

Low-cost deposits are only about 5.5 per cent of total deposits. The ratio for most banks is at least about 20 per cent. If Yes Bank is able to increase the proportion of low-cost deposits then profitability of incremental business could well be better than that of existing business. This would boost profit growth further.

Growth story

The stock is now trading at a price to earnings multiple of nearly 34 times its annualised earnings for the half-year ended September 2005. In terms of price to book value, the stock is trading at a multiple of 3.2 times. In terms of these multiples, the stock may appear expensively valued compared to larger banks. Being a small bank, and off a smaller base, Yes Bank can grow faster than its peers justifying the higher valuation.

At the end of September 2005, Yes Bank's net worth stood at Rs 537 crore. If we consider a return on net worth of about 20 per cent, then earnings per share would work out to about Rs 4.

The PE multiple would then come down to a realistic 16. This multiple is attractive considering the growth prospects for small private banks.

What is critical, however, is how soon Yes Bank will able to scale up business and achieve a return of net worth of between 18 per cent and 20 per cent. Achievement of this target before FY 2007 could lead to sizeable appreciation in stock price.

In contrast, delay in scaling up the business could reduce potential returns and remains the key risk to the recommendation.

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