Indian Banking Sector – A Quantitative view ( Part 1)

The following study is performed by me, utilizing the data from RBI website. The data used for Balance sheet and P&L are old  (as of March 2014), but the Price to book value data is taken as of February 2015.


The purpose of this study is to quantitatively identify the impact of Quality of assets and the ability to manage it, on the Market performance.


  • Higher the GNPA as a percent of advances, Poorer is the market performance
  • Higher the GNPA, banks provide higher provisioning
  • Higher provisioning leads to poor market capitalization
  • Private banks have better assets than public sector banks
  • Lower NPAs leads to better market performance


Observation 1


Observation 2

For every 1 rupee of loan advanced, a bank can expect on an average, 3% (from the chart) of it would become non-performing asset

  • Average NPAs carried by the banks in the country is 3.9% which validates the above fact
  • SBI is the leading provider of advances, with ICICI coming second
  • Of the total Loans disbursed, Public Sector bank disburse 44%, followed by Nationalized banks
  • State bank group is worst at managing their loans (refer pie chart)
  • Private sector bank’s contribution towards NPAs is the lowest (indicates why people favor private banks) ( would be observed as we proceed)


NPA & Market Performance

As the % of Non performing assets increase, the financial performance of the banks suffers, as it invokes interest loss and capital loss. Interest loss affects the profitability and capital loss affecting the balance sheet.  Hence, higher is the NPA, poorer is the operational characteristics of the banks, which should result in the poorer market performance. Since this is a plot for just one particular year, the future movements in NPA would determine the variations in value for the banks.

  • United bank of India fares poorer in terms of the NPA, as almost 11 rupees out of 100 lent would become GNPA for this bank. It trades at significant discount to the book value.
  • Yes bank has the lowest GNPA amongst all the banks and trades at nearly 4 times book value. A significant premium indicates the amount of confidence public has on this bank.
  • HDFC Bank and Kotak Mahindra are performing excellently in the market trading at around 5 times the book value, as their GNPAs are also lesser than 2%
  • Many banks are falling in the line of Under valuation, though they have lesser NPAs, they trade at a discount to the book value. Some names we can decipher are South Indian Bank, Jammu Kashmir Bank, Canara, Vijaya and Syndicate bank
  • Fortunately we see no overvalued banks in the chart
  • Some further studies can be warranted from this chart are,
    • Large and smaller banks
    • Higher NPA and Lower NPA performers
    • Public sector Vs Private Sector
  • Whether NPAs are the only reason for poor performance?


10 LARGE BANKS (Classified based on the assets)

Large 1

The lowest NPAs should indicate better performance of the bank financially and in the market. Accordingly, HDFC and Axis bank are performing excellently well, having the least NPAs.  Canara bank, BoB and ICICI form the next three banks having lower NPAs, but, except for ICICI, both Canara bank and BoB are trading below or near the book value. These two banks need to be studied better to understand their underperformance.  Among the top 10 banks, IDBI, PNB and SBI are the lowest in terms of asset quality, possessing above 5% as GNPA.  SBI indicates the confidence people have over the bank, though having poor asset quality among the larger banks, trades at a premium to market value.  Many questions can arise just out of this chart. Can a simple correlation between NPA and Market performance would throw us insights on which are better banks to invest in? How can one be sure that no other factors affect the banks? We will address these questions in subsequent studies.

If I have to explain the answers for the questions, the trend line indicates the banks which have higher NPAs are faring poorly in the market. It is a very logical thing too. But we need to understand the trend of each bank’s NPA in the recent past also to make a better judgment. Since RBI provides no such data, I am limiting my analysis to what I know and what is available.

Based on the above chart, if one has to think about investing, one needs to be cautious about investing in PNB, IDBI, SBI than in HDFC, Axis provided the asset quality remains the same.  One can explore the banks like Canara and BoB to understand whether value exists.

Large 2

Average level of provisioning in the whole Indian banking system is around 30%, hence anything above this limit can be mentioned as good. Higher the provisions for the NPAs, the profits would be lesser indicating the banks would perform poorly in the market. But in future the need for additional provisions is reduced, which enhances future profitability, hence market performance. Also higher provisions indicate the banks being more conservative and represent true facts on the loans which are NPAs.  In future, the benefits are two-fold for a bank which provides higher provisioning. In case of NPA rise, they have already shown higher provisions, hence the reduction in profits in future would not be that high. In case an NPA starts generating value again, the provisions would decrease, resulting in enhanced profits for the future. In such a scenario, HDFC and Axis (Lowest NPA banks remember?) provides the highest provisioning, hence higher market share. This could be the reason for the euphoria over the HDFC and Axis bank, where every analyst seems to be bullish about these two banks.

Let us go back to our Canara bank and BoB where we said, there is some value existing. Canara bank provides better provisioning than BoB. Canara Banks’ under performance is still confounding. If they have one of the lowest NPA levels and with higher provisioning, this bank can be called as conservative enough, yet it trades at significant discount to market value.   Let us look at different picture then.

All I have been talking about is the asset side. But a bank, which manages the quality assets, to enhance its performance would be measured by the return it generates. Hence bringing in ROE in this picture, the chart is given below. Higher ROE and Lesser NPAs constitute a best bank! And the same story unfolds here, as you see HDFC and Axis scores here. Whenever an analyst mentions choose private sector banks, especially HDFC and Axis, you now know the reason why.  Bubble Size indicates the bank’s Price to Book value ratio. Biggest bubble is of size 5!

Large 3

Canara bank, the return it generates on the assets, even with lesser NPA is not commendable, which results in poorer market performance. This answer almost as many doubts we had in the above paras. They are enhancing business at the cost of profitability is one thing which I can infer.

From the above, BOB again becomes attractive with almost 12-13% ROE, lesser NPAs, moderate provisioning, trading at 0.96 times book value! If one has to consider 10% ROE at least as a satisfactory measure of bank’s performance, only 4 banks stand out, and it can be visibly seen in the chart.

Favored Banks – HDFC, Axis, ICICI

Value – BoB, Canara

Never venture – PNB, IDBI, even SBI (but since this is the largest bank, one can to consider at lesser multiples)

10 SMALLER BANKS (Classified based on the assets)

Small 1

Lets get to the point straight. Those who think of venturing into LVB exercise caution. CUB, DCB , ING Vysya and KVB are better banks among the smaller banks.  KVB is relatively very safe to venture into, as they have higher provisions and lesser NPAs. As long as the slippage don’t go out of hand, it is an excellent bank.  Almost all the smaller banks which trades at premium valuations, have better asset quality and truer picture by providing higher provisions. We would look at how these banks trade with respect to ROE too.

Small 2

Needless to say, all the top performers have been the ones which are also generating higher ROEs. Surprisingly South Indian bank has an ROE of 16%, GNPA of just 1.5% and trades at 1 times book value! Is this the reason why this stock has been favored by Value investors?

Banks favored – City union, KVB, DCB, ING Vysya

Value – South Indian

Never venture – Laxmi Vilas, Dhanalakshmi

Study to continue…..


Demerger of Adani Enterprise Ltd., – A value creation?

Adani Enterprise ltd., a holding company, has decided to demerge its power, Transmission and ports businesses. Transmission business will be listed as a public entity post the demerger. The articles on the same has been available in the below links,

Now coming straight to the point,

As per the last article above, the approved ratios are like,

Pre DeMerger

AEL      –     1 @ 629 (Latest closing price)

Post Demerger

AEL       –     1          (Not known)

APorts   –      1.4123 (Assuming current price 340) = 480

APower –      1.8596 (Assuming current price 52)   = 97

ATL      –       1         (not known)

Out of the total of INR 629, INR 576 is the worth of Aports and APower, according to the current valuation.

AEL, being a holding company would certainly have a holding company discount applicable to its valuation. Holding company discounts are of 3 types, due to lack of control, lack of marketability and liquidation discount. MArketability and control are present with this company, hence the discount factor from these two factors can be safely assumed to be negligible. Liquidation is the process which is happening, hence whatever discount which it would have, would dissipate now.

Most holding companies are having a discount of 20-50% from the market value, i for the conservatism, chose, 20%. ( AEL has risen 14% already in the past 2 days, leaving room for a possible 6% increase). So one who would like to enter now can possibly expect 6% increase from the current levels, ie., to 667.

At 667, the businesses of AEL and ATransmission are worth 90 Rupees per share. (One needs to be confidently sure that the business of AEL and ATransmission to be higher than 50(629-576=53) rupees for any meaningful profit. I am currently in the process of valuating this worth of AEL’s Coal mining, trading and Transmission business)

Are there any arbitrages in this transaction? My answer is, possible.

1) The holding company discount will hold the validity of my calculations. If the holding company discounts are higher than 20%, the potential for rise in share prices are higher.

2) ATransmissions, a non listed entity which would get listed. Generally, a private business is worth less than a publicly listed, due to its lack of marketability. hence, i expect the business valuation to be better than what its worth would be in future.

Vardhman Acrylic – A Bargain, But worth it?


Vardhman Acrylic is into the business of manufacturing Acrylic fibre which finds its application in the textile industry. Since owned by Vardhman Textiles, this business is much like a backward integrated player for the Vardhman textiles. Zero Debt, Strong Ownership pattern, continuous, but steady sales growth are some of the positives for the company.

Bargain Value

The company’s Current market Cap is 286 Cr. But it has 200 Cr in Cash and investments alone. Hence the entire operating business is trading at a value of 86 Cr. If we try to value only the part of business which is operational to generate the cash flow, we might find the value of the business as a whole.

Method 1: This company has no debt and pile of Cash + investments. It could be a Debt capacity + Cash bargain stock (applying the concept studied under Sanjay Bakshi).  Assuming they can borrow at 12% ( Crisil AA- rated!), if I assume they can take a maximum debt with an interest coverage of 3 (margin of Safety), they can borrow a debt upto 97 Cr. (EBIT/(Int.Coverage * interest rate). This when added with the current cash + investments could put the company at a potential of 297 Cr which is 5% higher than current market cap. (But this is too small a difference) ( any lower rate of borrowing would fetch higher value for the above obtained figure. ( Remember this debt capacity bargain is for the part of ownership of the earnings, not the company as a whole)

Another method – If I take the average FCFF of the past 5 years, and assume no growth in the FCFF for the prolonged period, discount it at 15%, I would get a value which is 380 cr which is 33% higher.  Else, if I discount it at 20% I would get around 278 Cr, which is similar to the current range.

Catch here is the assumption of no growth. Will the firm be able to grow FCF at higher pace than 0% in the future? We need to be certain of that.  This is one crucial question to ask, because, the company’s current valuation is dependent on discounted cash flow of future valuations! Some stories follows,

Acrylic Fibre – Industry Growth story


Based on the above table, I see the acrylic fibre is not such an attractive option for growth in the past 20 years. The consumption and production hasn’t grown over the past twenty years.  The fashion trend and the climatic condition could only result in the fibre consumption and production to increase. Also, China is planning huge investments in the space, which could result in supply overpowering the demand, by which the prices would be subdued. But I believe the company’s major source of income comes within India. India’s market is slightly deviating with respect to the global markets, but when there is an over abundant supply, there is a great chance the products from external markets coming into our country. In such a case, the competitiveness within the industry would increase, which too is not attractive.

Margin story

Margins in the company are continuously following a wavy pattern over the period of years. If there is a Margin reduction, that can be either due to the price reduction or cost increase ( or both). Prices within Indian Acrylic fibre didn’t decrease because this industry is growing at a higher pace than international peers, and there is a demand for the fibres, which results even in imports. Prices needs to be competitive, as low priced imports comes into the Indian markets. The cost increase might not be due to the plant operations, as they might be operating at higher capacity utilization. Some external factors which influence the costs are,

  • Raw material – Acrylonitrile prices are directly proportional to Crude oil prices (Favorable for current year)
  • Devaluation of rupee& reliance on external sources for procurement of raw materials ( Not so favorable for current year)

In the current context of falling crude oil prices and depreciating rupee, the company’s position is, I believe, wouldn’t be much positively benefited this year. Anyhow, with the kind of industry, something is always better than nothing.

Capital Expenditure Story

They are not investing in expanding the capacities at all. In edelweiss report, it was mentioned that 20000 MT is the capacity of the plant.  In the latest annual report they have mentioned their production during the current year is 20478 MT. It could mean they are operating in the shifts, as they have made no investments in capex.  It could also mean that their plants and equipments would depreciate faster than they can anticipate.  With such a condition the company would have to invest in the maintenance CapEx continuously, so that they can continue to operate at the same way. I sense a maintenance CapEx spends such as, replacing machines/equipments etc., would increase in the upcoming years, reducing FCF. A capacity expansion in this industry  which is degrowing or growing slowly would only be detrimental. That would explain the following, ‘All management does is to be fairly interested in buying and selling of mutual fund/bond based investment vehicles.’

Investment Story

The investments over the period has been found to be earning a decent 10-12% return for the management every year. Majority of their investments are into the Mutual funds and Bonds, which management is actively managing every year. With the current year has been extremely favorable for the Indian Markets, it would be extremely sensible to believe their Other Income to be boosted by a huge amount. (200 Cr investment, even if i assume a 15% return, it could result in 30 Cr).


Though Valuation wise the share is attractive, this wont fall under the type of business which i continue to hold for a prolonged period of time.

Run Baby Run, Says the Red Queen, Or You Will Go Nowhere

Excellent piece on Value traps!!

Fundoo Professor

Two days before my course started at MDI on Friday, I had a fall.

A rugged stone appeared from nowhere while I was running around a tomb. I fell. Hard. Bruised all over my arm and my knee. Skin off my palm. Bleeding, limbed back home, got fixed by a wife and a doc. It hurt like hell.

But now I just can’t get the Red Queen out of my head.

You see, I was trying to get somewhere. From my present state of moderate stamina to be able to run a half marathon by the end of this month. But for now I am back to where I started, which is basically nowhere. Just as the Red Queen said. I should have stuck to running on the boring treadmill (on which you really get nowhere) instead of running around the tomb of a king called Humayun who died 457…

View original post 1,655 more words

Special Situation – Merger of Shasun Pharma and Strides Arcolab

Shasun Pharma  CMP – INR 181
Strides Arcolab CMP – INR 743 ( A special dividend of INR 105 has been announced)
Approved merger ratio is for every 16 shares of Shasun, investors would get 5 shares of Strides arcolab.
16*181 = 2976
5* 638 = 3190  (after excluding dividend)
Meaning if i invest in Shasun pharma currently, and the shares of Strides arcolab to stay at the same level, it would be 7% profitable (within the duration of merger).
I believe if this merger was to happen today, it would be 7% profitable ( Within a day) . But, since the time frame is not set so far, we might have to play a wait and watch game for this opportunity to be fruitful.
Duration plays a critical role at establishing whether your investment would turn immensely profitable or not! I believe assuming above price to stay for Strides, with 7% return i can plan to wait for a period of six months! ( approximate annual return would then by 14%, which is well and good).
I enter a long in Shasun tomorrow @ 181 and Shares of Strides moved down – on the reason that its earnings and margin dilutive for Strides, then i might even have to consider exiting or start looking at the fundamentals of Strides. Alternately, If Strides moves up, the possibility of earning higher return is huge!

Special situation – Mangalore Chemicals and Fertilizers limited

Mangalore chemical & fertilizers ltd., a profitable concern of Vijay Mallya, has received competitive bidding from Deepak Fertilizers and Zuari-UB group combine. Currently these parties own, ~25% and ~34% respectively. 27% stake is available with the public, hence owning it, would result in the control of the entity. Since UB Group is also involved, Vijay mallya would like to retain the company with himself combining with Zuari group, whose chairman is a long time friend of Mallya.

Initialy Deepak fertilizer provided a bid for acquiring rest of the stake from shareholders at INR 68.55. Shares of MCFL was trading at around INR 74 rupees. The competitiveness of the situation can be explained by the following. Both the parties are trying to take control of MCFL right under the other party’s noses, by acquiring stake from other stakeholders since 2012. For Deepak and Zuari, MCFL would provide a platform for Entering south india’s market. Vijay Mallya wouldn’t like to lose his one successful  enterprise. Though, he is one loser if any party wins, its just a presumption that he would like to get a share of his entity.

It is highly probable that the share offer could further extend beyond INR 68.55, as illustrated from the above. One could have sensed a profitable opportunity in the deal and gone long in MCFL. No fundamentals or macro factors comes into the picture, as this is a trade like situation. Fundamentals would be taken care by the prices offered by competing parties, all we need to do was just to wait for the share prices to appreciate. The competitive bidding got fiercer with Zuari rising the offer price initially  to INR 81.6 and Deepak raising it further to INR 93. Share price went ahead further to INR 101, i believe with the expectation that there may be a counter offer. This scenario could have resulted in ~33% profits within a week’s trading! But am just waiting, whether this scenario would turn like a popular quote,

” The thrill of the chase, often blinds the value of the catch”

I believe above is what the share holders who have made the share price of MCFL to rise to INR 103, would pin their hopes on. 🙂

Keenly watching!