Saturday, March 29, 2014

State bank of India (SBI) - massive branch network but the operations could be better

BSE: 500112|NSE: SBIN|ISIN: INE062A01012

The socioeconomic impact of State Bank of India (SBI) has been staggering and cannot be overstated. It is the backbone of the Indian economy and the equivalent of the "too big to fail" banks in the US sub-prime crisis. As always that comes with lower efficiency but the Indian economy and banking system would be far worse off had it not been for SBI.

1. How good is the moat?

Grade C moat
  • The bank has a huge balance sheet and a sales and distribution network that might be the envy of even global players (14800+ branches!)
  • Gross NPAs stand at 4.75% at the end of FY 2013 and 5.7% at the end of Dec 2013 which is very high and leads to a low net interest margin and raises questions of efficacy of the credit approval process
  • Despite the NPAs and provisioning the return on equity is fairly high at 15%+. The provisioning coverage ratio stood at 66% in FY2013 which is far lower than HDFC bank & Axis Bank at 79%+.
  • The entire moat of any bank depends on its ability to find reliable credit, lend money, protect its interest, and get it back on time on the agreed terms. The reason why I believe the moat is not great is because this part of the process is not great at SBI.

2. What are the risks?

  • Bad loans will continue to get made. When the gross NPAs are 5.7% (Dec 2013) then the question one begins to ask is whether the NPAs themselves are being demarcated correctly or not.
  • Efficiency improvement rate has been good as the profit per employee has been rising, but if it does not continue to improve every year at the same pace then there might be concerns on the cost side.

3. Financials

  • Efficiency is low relative to HDFC Bank and Axis bank - profit per employee is 6.45 Lakhs
  • Net margin is hovering around 9% which is again much lower than HDFC Bank at 15%+
  • Net interest margin is at 3.19% for 9M ended Dec 2013 - which is despite the loan loss provisions.
  • Loan loss provision % has dropped to 58% in Dec 2013. This is despite 12% higher loan loss provisions in the 9M of FY2014 than the previous year.
  • Equity % of assets is only 5.8% which is around 9% for HDFC Bank. This clearly signals a higher risk even though the CRAR and Tier 1 capital ratios of SBI are not that off from HDFC Bank or Axis Bank.
  • Dividend % of earnings is around 17% to 19% - which is healthy.

4. Soft factors

  • No insider trades reported worth mentioning in the last quarter.
  • The government of India owns 62%+ of the company. Banks, financial institutions, Indian insurance companies and resident individuals put together own about 20%. FII only own about 13%.
  • Director shareholding clearly stated - which is a good sign for corporate governance. The not so good news is that of the 16 directors on the list 7 don't own any shares and only 1 owns over 700 shares. Makes me believe that the directors might not think this is a value investment either.

5. Pricing

  • If SBI were to be able to control their NPAs their net interest margin would be unbelievably high as their cost of funds is already very low. It can be lowered even further if the branch network were used more efficiently. Clearly this should be watched for improvements in operations and might become a formidable moat in the future.
  • It trades at around 14 times earnings and can be bought today at a similar price as in 2007!
  • I will not go into detailed pricing as the risk is very high and the moat is fairly dry due to the high risk. This is probably not a value investment.