The Hindu Business Line : Union Bank of India: Invest at cut-off

AN INVESTMENT can be considered in the public issue of Union Bank of India. Robust growth in business, strong financials, a well-diversified loan portfolio with headroom in retail lending, and a well-hedged investment book make the stock attractive.

Stiffly valued

In terms of valuations, however, Union Bank appears stiffly priced. The stock trades at a price-to-book ratio of 1.7 times its trailing 12-month earnings. This is at the higher end of the spectrum compared to the valuation of other public sector banks. However, considering the pace of its growth over the past few years — which is likely to continue in the medium term at a steady rate — the valuation appears justified. Union Bank of India has one of the higher debt-equity ratios in the banking industry. This exaggerates its return on net worth, which at about 23 per cent, puts it in the industry's top league.

Post the equity expansion, there is likely to be a reduction in its return on net worth numbers. However, a price-to-earning multiple of about seven and a dividend yield of 3.2 per cent offer comfort on the downside. Over the next few years, the earnings growth should be enough to deliver reasonable returns. Invest with a one/two-year perspective.

Robust business growth

Union Bank is among the few PSU banks to record consistent business growth over the past few years. The bank kept the growth momentum in the third quarter too. Advances rising at 35 per cent and deposit accretion at 26 per cent outpace the industry average of 30 and 19.4 per cent respectively.

The growth in the net interest income (NII) was also a healthy 10 per cent, driven primarily by loan growth. We expect the net interest margin (NIM) to be stable at about 3.1 per cent on the back of increasing competition, which is likely to exert pressure on margins.

The bank's dependence on treasury gains has reduced gradually. With opportunities in treasury thinning, Union Bank expects the incremental investment in SLR, together with the higher yield on credit, to improve profitability. In this backdrop, the bank is likely to earn return on assets in the range of 1.1-1.3 per cent over the next few years.

Diversified loan book

Union Bank has a well-diversified loan book with exposure to SMEs, infrastructure, agriculture and retail sectors. Lending to infrastructure has picked up pace followed by agriculture and retail. Retail loans, now at about 20 per cent of net credit, give it enough room to expand.

The expansion in the loan book has not affected the asset quality. On the contrary, the bank has recorded remarkable improvement on this front. Its bad loans, as a percentage of net advances, fell from 3 per cent in 2004 to about 1.2 per cent as on December 2005.

About 93 per cent of the bank's investments in SLR is under the held-to-maturity (HTM) category. As such, if the interest rate goes up, mark-to-market loss on the bank's investment portfolio is likely to be minimal.

Well-capitalised

Post-issue, Union Bank's capital adequacy ratio of about 10.5 is likely to improve. Further, the bank has about Rs 550 crore in the Investment Fluctuation Reserve. If this were included for computation of the Tier-1 capital, the capital adequacy ratio would improve further.

The bank has one of the higher credit-deposit ratios of about 72 per cent among public sector banks. This means that, should there be a sharp upturn in interest rates, the bank would not be as badly hit as many of its peers.

Concerns

Union Bank's relatively low proportion of low-cost deposits (about 30 per cent) is a matter of concern, as this may limit the scope for improving the cost of funds. If yields on advances and investments do not improve, margins are likely to come under pressure. However, with the implementation of core banking solution gaining pace, it is likely to enable the bank improve its low-cost deposit base and boost fee income.

There is also uncertainty about the proposed merger between Union Bank and Bank of India. With the Finance Minister in favour of mergers among public sector banks, uncertainty about the terms remains a concern.

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