Is the SBI stock a bargain?

How does SBI, the largest Indian bank, compare with its private-sector rivals? Rex Mathew analyses

The SBI stock has appreciated more than 40 per cent from the lows it touched during the May-June 2006 market slump, but has still underperformed large private sector banking stocks and PSU peers like PNB and OBC. Even at current prices, SBI attracts much lower valuations than the large private sector banks.

Despite being much larger, SBI's market cap is over Rs10,000 crore less than the No.2 ICICI Bank's. As of last weekend SBI had a market cap of Rs57,532 crore while ICICI Bank was valued at Rs67,661 crore. The much smaller HDFC Bank, whose balance sheet size is less than 20 per cent of SBI's, had a market cap of Rs31,355 crore.

SBI is valued at around 1.35 times its 2006-07 book value and close to 1.2 times its 2007-08 book value while ICICI Bank trades at around 2.75 times its 2006-07 book and close to 2.5 times 2007-08 book value.

In comparison, HDFC Bank trades at close to five times its 2006-07 book value and around four times the 2007-08 book

Private sector banks enjoy a considerable premium as they are seen as much more aggressive and have much larger retail exposure. Retail lending has grown much faster in recent years and the private sector banks have made the most of it.

As they have cornered a very good chunk of the high-income retail customer base, the private banks are definitely at an advantage. Retail advances were only 25.75 per cent of total advances of SBI, as compared to 69 per cent for ICICI Bank, even after a growth of over 26 per cent in the latest quarter over the previous year quarter.

Credit demand from the corporate sector has expanded at a lower rate as companies now have access to cheaper sources of funds, including overseas borrowing. Net interest margins in corporate lending have also declined considerably in recent years.

Private sector banks also have a much more diversified business portfolio than PSU banks, which rely considerably on lending operations and are exposed much more to changes in the interest rate cycle. The proportion of fee-based income in the total income of private sector banks is significantly higher and they are expanding aggressively in segments like retail remittances, which offer significant growth potential.

The absence of dominant shareholders in private sector banks has led to market expectations that large foreign banks would acquire some of these banks when the RBI allows them to do so after 2009.

Citibank has already built up sizeable stakes in both HDFC and HDFC Bank and the possibility of a 3-way merger between Citibank India, HDFC and HDFC Bank after 2009 cannot be ruled out. The government of Singapore, which owns DBS — one of the largest banks in South East Asia, is the single largest shareholder of ICICI Bank. These expectations have also led to higher valuations for the private sector banks.

Private sector banks also have a clutch of subsidiaries in fast growing businesses like insurance, fund management and stock broking, which add to the value of these banks. Though SBI also has a presence in these sectors, except stock broking, the possibility of value unlocking through spin-offs in future is perceived to be limited.

However, considerable value would be unlocked if the seven SBI associate banks like State Bank of Hyderabad, State Bank of Travancore, State Bank of Bikaner & Jaipur, etc, are merged with SBI. All these associate banks have already been operationally integrated with SBI, which is seen as a prelude to a full merger some time in future. The combined entity would have a substantial lead over its competitors in terms of branch network, customer base, access to cheap deposits, balance sheet size, etc.

As the economy continues to expand a rapid clip, income growth in semi-urban and rural areas would pick up. If the retail credit demand growth witnessed in urban areas over the last many years extends to semi-urban and rural areas, SBI would be one of the major beneficiaries. If it can get its act together, SBI can catch up with the private sector banks in retail lending as it has a very large branch network and customer base in semi-urban and rural areas - where the private sector banks have a significantly smaller presence.

The government has already approved the necessary legal amendments to the SBI Act to allow changes in the capital structure of SBI associate banks. The central government is expected to acquire the majority stake held by RBI in SBI by next year. If the government gathers enough courage to bring down its stake in SBI over the next few years, it would definitely lead to a significant re-rating of the stock. The low valuations of SBI give the stock much more headroom to rise than the private sector banking stocks.