The amalgamation of United Western Bank with IDBI is likely to add value to the latter over the long term. The merger is likely to help IDBI expand its retail presence. This, coupled with the unlocking of value in its investments, is expected to result in a surge in earnings growth.

Company Background

Industrial Development Bank of India Ltd (IDBI) was incorporated in 1964 as a development financial institution (DFI) and has now transformed itself into a full-service commercial bank. As on April 30, 2007 , the bank has totally 432 branches (230 belonging to the erstwhile United Western Bank), 18 extension counters and 523 ATMs spread across 255 cities. In FY07, IDBI acquired United Western Bank (UWB) for a consideration of Rs 275 crore. UWB was merged with IDBI, effective from October 3, 2006 , which gave IDBI 230 branches in one stroke. Its total business has increased over Rs 105,800 crore in FY07 (including UWB), a healthy growth of 36% y-o-y.

Investment Rationale

Unlocking value from investments
IDBI has got a strong investment portfolio with substantial stakes in many unlisted and some listed entities. Besides these, it also has stakes in companies like Gujarat State Petronet Ltd, Ispat industries, etc which may turn value creators going forward. Overall, unrealised gains on quoted and unquoted equity book is expected to be around Rs 2,200 – 2,500 crore, which comes around Rs 32 –35 per share of IDBI. A 2% stake in NSE stake has been sold for Rs 200 crore and balance 5% stake still exists having valuations of Rs 500 crore. We have not valued the subsidiaries businesses in above gains.

Business gradually gaining momentum
In FY07, IDBI’s advances grew 18.45% to Rs 62,471 crore, whereas deposits swelled by a robust 66% to Rs 43,354 crore. If we exclude UWB, growth in advances was 11% and deposit growth 42%. Advances are expected to grow at average 15 -17% during next two years and deposits at 28-30% due to low base effect. The merger brought in a diversified business portfolio, including small & medium enterprises (SMEs) and agri-business, a wide branch network in rural and semi-urban areas and skilled and experienced human resources. The amalgamation, therefore, strengthened the efforts of IDBI to pursue its business strategy more vigorously. Retail advances form 15.7% of total advances in FY07.

Focus on asset quality
The bank’s asset quality has improved with gross NPAs declining to 1.9% in FY07 from 2.0% in FY06. The Net NPA ratio stood at 1.12% in FY07, as against 1.01% in FY06. The increase in the net NPAs was on account of the NPAs it acquired following the merger of UWB. We believe the company will be able to maintain net NPAs at 1% levels on account of rise in recoveries expected with turnaround of industries.

Foraying into new businesses
IDBI is planning to enter life insurance through a joint venture with Fortis and Federal Bank. It also plans of forming an asset management company together with its IDBI Capital Markets, its wholly owned subsidiary and has intentions of entering private equity business. All these initiatives should add further value to the stock.

Well capitalised with CAR at 13.7% to sustain future growth
IDBI’s tier-I capital adequacy ratio (CAR) was at a high level of 9.1% which is adequate to be supportive of its long-term business plans and is deployed effectively to optimise its cost.

Risks and Concerns

Low NIMs among public sector banks
IDBI still has the burden of high cost and CASA deposits at 26-27% levels, which leads to higher cost of funds. Though debts have been re-priced, overall cost of funds at 6.83% continues to put pressure on net interest margins (NIMs). NIMs have improved from 0.5% to 0.8% in FY07, but still continue to be lowest in the industry. Further, rising interest rates remains a key concern for the sector as a whole.

Sharp increase in NPAs
Any downturn in the economy may lead to a surge in NPAs requiring more provisioning. This could impact IDBI’s profitability.

Financials:

The bank’s net interest income (NII) grew by extra ordinary 73% to Rs 657.9 crore in FY07 from Rs 379 crore in FY06, mainly due to the UWB merger. Operating expenses have seen a dip of 10% on overall basis in FY07 assisting the profitability to grow 12.5% y-o-y to Rs 630 crore from Rs 561 crore. We expect NIMs to rise gradually from current 0.8% over 1% in FY08E with re-pricing of high cost borrowing and marginal increase in yields. Yield on total assets has remained stable at 7.84%, whereas spreads have gone up marginally from 1.47% to 1.50%.

Valuation

At the current price of Rs 112.75, the stock trades at 1.2x its FY09E ABV of Rs 96 per share. The bank is expected to show a surge in earnings growth due to realisation of profits in most of its old strategic investments. Further, its core business is expected to grow gradually with net profits growing at a CAGR of 17 -18% over the next 2 years. We believe its RoA at 0.6% will continue to be maintained, with RoE improving to 8.2% in FY08 from 7.6% in FY07. We expect the bank to trade at 1.4x FY09E ABV giving a target price of Rs 135.30 an upside of 20% over the 6-9 month time frame.

Technical Outlook

On the charts, the stock made a low of Rs 49 last year and bounced from those levels. It formed a very good support at the 200-day moving averages at Rs 73.50 and is in a long-term strong up-trend. It has broken its short-term resistance of Rs 109.50 and its now attempting to re-test its high of Rs 130. All strength indicators have been moving up and are in the overbought zone, but have some more space to hit new highs.