Centurion Bank of Punjab - Buy

Among mid-size private sector banks, Centurion Bank of Punjab (CboP) presents a good investment opportunity for investors with both short and long holding time horizons.

The stock is currently quoting around Rs 45 (face value of Re 1) and at these levels, the valuation is out of tune with multiples for banks in this or other categories.

The latest per share earnings, for instance, is around 85 paise and the book value per share is around Rs 8.

Therefore, the valuation multiples (price-earnings multiple of 60 and price-book value of 6) based on historic earnings are stiff indeed.

But by entering the stock now, investors could be well placed to reap the rewards of all the efforts of the past four years in first stabilising the bank’s business and then rendering it fit for growth.

After the almost headlong rush into impaired assets in the second half of the 1990s and consequently the stabilisation/recapitalisation in the first years of the new decade,

CBoP appears quite well positioned now to capitalise on the large and rapidly growing business opportunities.
Vote of confidence

The fact that the Reserve Bank of India has approved the merger of the loss-making (but well-networked in a particular region) Lord Krishna Bank with CBoP can be taken as a strong vote of confidence in the strength and growth prospects of CBoP’s underlying business.

It is proof that the bank’s balance sheet is now strong enough to absorb a loss-making bank and also that its business model is robust enough to make good use of the merging bank’s branch network for further expanding geographical and business reach.

Lord Krishna Bank will add about 120 branches with more than 80 per cent of them in Kerala/other southern states where business prospects traditionally have been good.

The earlier merger of Bank of Punjab with Centurion Bank in October 2005 also appears to have been successful, if the growth in key parameters such as deposits, advances in the past two years is any indication. Long-term investment prospects, therefore, look good.

The strong foundation, the return to sustainable profitability and the scalable business model also mean that a bank such as Centurion could be a key takeover target when the banking sector is opened up for more foreign participation in 2009.

Investors in the Centurion Bank stock may benefit from such a development, even in the short/medium term.
Business operations

The bank seems to have developed a niche in retail lending/distribution of financial products and at the same time has substantially stepped up corporate lending. This overall balancing could stand it in good stead as it seeks to scale up business.

Retail loans (two-wheeler loans, commercial vehicle financing, personal loans, housing loans, etc), which formed as much as 90 per cent of total advances in 2005, have declined to around 70 per cent currently. Corporate loans have increased their share of total advances from 8 per cent to around 30 per cent in the same period.

While the wholesale/corporate/SME relationships provide stability to the revenue stream though margins could be lower, some retail segments generate higher margins.

The bank has a relatively high net interest margin of around 4.6 per cent. The non-lending activities — distribution of financial products such as mutual funds, insurance — provide a platform for capturing income flows from high growth financial services activities.

Non-interest income accounts for around 25 per cent of the bank’s total income, which is high for a bank of Centurion’s size. It is notable that only ICICI Bank, with its much bigger scale of operations, has such a high share of non-interest income.

While such high non-interest income is welcome in one sense, it could also add volatility to the overall earnings in a business downturn.

Also, such fee-generating activities imply a higher operating leverage generally for banks — evidenced by higher employee costs.

Centurion’s employee costs, for instance, are relatively much higher at 16 per cent of total expenses against around 10 per cent for comparable banks.
Business growth, Risks

Advances have grown at an annual average rate of 125 per cent in the past two years. Deposits also have largely kept pace growing at around 105 per cent.

The bank appears to have contained growth in NPAs despite such rapid asset build up with net NPAs at around 1.3 per cent in March 2007 down from 2.5 per cent in March 2005.

Provisioning coverage for NPAs has come down from 65 per cent in March 2005 to 55 per cent in March 2007.

The increased focus on corporate lending has probably helped in lowering net NPAs despite lower provisioning coverage.

Nevertheless, net NPAs remaining above 1 per cent is a cause for concern. A higher CASA share in total deposits (around 30 per cent now) also would provide more comfort.