Buy Canara Bank

Canara Bank
BUY
Price: Rs398 Target: Rs480 (Mar’11)

Coverage ratio concerns exaggerated

* Low coverage ratio but concerns exaggerated: CBK’s coverage ratio at 24.5%
as of 3Q10 is the lowest amongst peers. However, concerns are exaggerated
based on a) higher proportion of sub-standard and doubtful I category gross
NPLs (99.7%) resulting in lower provisioning requirements (Exhibit 2), b)
aggressive NPL write off policy of the bank (which results in lower effective tax
rate; 3Q10:19%), c) coverage ratio including technical write-offs stood at
74.04% as of 3Q10. We are factoring in a 46% increase in loan loss provisions
and gross NPLs of c.3.1% vs. c.1.8% currently. Despite higher credit costs
(c.105 bps vs 73bps in FY09), CBK is expected to deliver healthy ROE of c.19%.

* Positioned for growth with strong CAR and 73.2% government ownership:
We expect loan book growth of c.17% CAGR over FY09-12E driven by uptick in
industrial activity and improved economic environment. We believe CBK is
geared to capitalize on growth opportunities due to its strong CAR position
(3Q10: CAR of 14.4% with tier I of 9.2%) and government holding of 73.2%
(additional capital can be raised by selling government’s stake).

* Life Insurance stake valued at Rs53 per share: CBK has a 51% stake in life
insurance JV with HSBC and Oriental Bank. The insurance venture has been able
to garner a market share of c.3% YTD despite stiff competition. We now ascribe
a value of Rs53 per share for CBK from its insurance JV assuming a) market
share of c.3.5% by FY12E amongst the private players b) NBAP multiple of 17x.

* Significant headroom for FIIs: FII ownership in the bank is one of the lowest
(3Q10:11.5%) over the past 5 years as against the regulatory ceiling of 20% for
SOE banks. Given the improvement in the macro environment coupled with
higher credit growth going ahead, we believe that significant headroom in CBK
for FIIs could act as a technical trigger (Exhibit 3).

* Upgrading estimates and introducing FY12E numbers; ROE to touch c.19%
by FY12E: We raise our FY10E and FY11E earnings estimates by 53% and 25%
respectively primarily due to higher treasury income. We also introduce FY12
estimates and expect the bank to deliver ROE of c.19%.

* Attractive valuations; upgrading to ‘BUY’ with TP of Rs480: Based on a
normalized ROE of 19%, we value the banking business at 1.25x FY12E book
implying value of Rs426 per share. Further, we value CBK’s 51% stake in the life
insurance JV at Rs53 per share. Consequently, we raise our March’11 TP to
Rs480 which provides an upside of c.20% from the current levels. BUY.