Buy rating on SBI; Inching closer to inflection point

Restructuring of Rs 119 bn faded an otherwise excellent quarter. Asset quality is much better than headline and much better than peers. Large corporate loans are still at risk. Cost curve is fully baked, to inflect sooner. High provision coverage and decent capital, it’s a story worth owning. We have cut earnings, and revise price target to Rs 360.

Better NIM and help from costs to boost core PPOP: Domestic NIM (net interest margin) improved by 6 basis points owing to interest income on income tax refunds (one-off), while foreign NIM improved 12bps sequentially. Better asset quality going forward should help NIM—low interest reversals. Deposit cost should plateau in three quarters. Core pre-provision operating profit (PPOP) was up 5.1%—the base was high. Most costs are fully baked in while the wage hike and pension costs won’t arise or not be material. As the wages are tied to inflation (DA is 110%), lower inflation will help. Fee income remained muted, growing at 9.5%. Loan growth consolidation continues (+7.5%)—guided for 14% in FY16.

Asset quality much better: Slippage ratio fell to 2.4%, adjusting for restructured assets, it was down to 2%. Expect this to go down further. Gross NPA fell to 4.27% from 4.92% sequentially, helped by sale of assets. Provision coverage ratio improved to 69%. Relatively, SBI’s asset quality is much better.

Tweak estimates: We have cut EPS (earnings per share) estimates by 14-16% for FY16/FY17 led by a drop in loan growth numbers and some compression in NIMs (7 and 14 bps). We have broadly retained the expense ratio while bumping up the credit cost by 10 bps. Even at these sharp cuts, we remain above consensus and believe the risk of positive surprise is very high–better operating leverage and asset quality.

Valuation/risks: We value SBI at 1.8x P/B (Mar 16), 8.7x P/E (12m to Mar 17) on a consolidated basis, vs five-year averages of 1.4x and 8.6x. Key risks are weak asset quality and weak loan growth. NIM saw a bump up on one off: Domestic NIM improved by 6 bps owing to interest income on income tax refunds. While the slippages were lower, the higher restructuring should have resulted in higher reversals (Funded Interest Term Loans –FITL). Lack of growth and better-rated corporates funding through the cheaper debt market could be a headwind on yield on assets in a few quarters.

SBI continues to report a rising cost of deposit, up by 10 bps in last eight quarters—people moving from savings to term deposits.

Core PPOP muted: Core PPOP was up only 5.1%, while employee expenses were up 22%. The other expenses too were up 19% driven by one-off non-budgeted costs –we think–in supporting the government’s financial inclusion initiative resulting in account opening charges, card issuances and payments to business correspondents. Since two other government schemes are running in parallel (accident and life insurance), some part of this cost may recur.

Fee income stayed muted, growing at 9.5%, and could remain muted in the absence of loan growth.

Loan growth was muted: SBI remains conservative with loan growth of 7.5%, far below industry average. It is also conservative about growing the SME and mid-corporate portfolio. Much of the growth came in the Large corporate space, and, much of it is coming through refinancing and not via new lending demand revival. We see revivals taking shape in H2 and pencil in 15% loan growth.

Asset quality seems to be improving: Asset quality got better and was much better than peers. Slippages are going down although restructuring was higher sequentially and ahead of expectations. If we adjust the slippage ratio for slippages from restructured assets, the slippage from the loans excluding the standard restructured loans fell from 3.5% to 2% in two years. The management says higher volume of restructuring in last two quarters also included assets that were not very weak. So we think the slippage ratio in next few quarters could surprise big-time.

The impairment formation ratio (fresh NPA and restructuring) that had steadily declined from 8.9% in Q4FY13 to 4% by Q2FY15, reversed its trend to close at 5.5% in Q4FY15. In Q4, SBI restructured R119 bn of loans. The pipeline of restructured assets is R26 bn. Gross NPA fell to 4.27% from 4.92% sequentially. There was a sale of NPA of gross book value of R45 bn (including written -off assets of R4.85 bn). The provision carried against this was R11.04 bn or net book value of R29.21 bn, which was sold for a consideration of R12.32 bn (R2.24 in cash and rest in security receipts). For the full year, SBI sold R124.78 of gross book, with provisions of R38.71 bn for a net book of R69.81 bn, and sold for a consideration of R60.56 bn. Provision coverage number improved to 69% (including written- off assets) and 51.4% on a core basis.