Buy City Union Bank Ltd For Target Rs.206 - HDFC Securities
City Union Bank Limited (CUBK) is a mid-sized private sector bank focused largely on working capital finance to small manufacturers and traders. City Union Bank has established retail franchise, granular asset and liability base, strong capitalisation (CET I ratio of 16.29% as on September 30, 2020) and strong liquidity profile with liquidity coverage ratio of ~292% as on September 30, 2020. The bank has healthy profitability indicators with return ratios above the private banks’ average. CUBK's niche lending to small and medium businesses is building high pressure on growth and asset quality and can keep financial performance sub-optimal over next few quarters. The bank’s niche positioning, strong SME relationships, better customer acquisition through referrals and regional focus would help the bank to post loan growth of over 12-14% in FY22-23.
CUBK has all the right ingredients, which include conservative management, unparalleled lending franchise, stable margins, superior return ratios across cycles and a well-capitalized balance sheet to deliver steady performance over the years. Although the net profitability has moderated in the last couple of quarters, given the provisions of Rs. 317cr or 0.91% of net advances as on September 30, 2020 for Covid-19 induced asset quality stress; its NIMs are likely to remain stable given its focus on high yielding MSME segment. CUBK’s granular deposit base, reliance on retail term deposits and a low proportion of corporate deposits helps it maintain stable funding cost.
Valuations and Recommendations:
City Union Bank has delivered steady performance on account of its conservative management, tight control on asset quality and superior return ratios across cycles. Focus on small-ticket sole banker business model, expertise in southern India’s niche business segments, viz MSME, traders and agri loans, and weak health of regional PSBs will drive higher loan growth. The asset quality pressures are expected to remain high for the bank in the near term, given the vulnerability of the target borrower segment MSME and traders (~51% of loan book). The management has provided a slippage and restructuring guidance of 3.0%-3.5% and ~5%-6% of advances for FY2021, which is likely to exert pressure on the asset quality and net profitability in the near term. Comfortable capital position would provide cushion to weakening asset quality metrics. Improving loan growth, diversified revenue profile, controlled C-I and lower credit costs should aid RoAA of 1.4-1.5% over FY22-23E. We believe that there is an ample opportunity for the bank to expand its presence across the country in the years to come.
City Union Bank’s key strength lies in robust assets side of the business and the bank’s ability to gain credit market share with stable credit quality. Though we remain optimistic on its retail focus and the segment is caters to; we are cautious on growth stance because of likely higher delinquency rates and credit costs in MSME segment. We like CUBK due to its high yield SME book focused on working capital (close to two thirds), high collateral cover (barely 1% unsecured) & sticky retail-funded liability base with largely matched ALM resulting in superior NIMs. We think the base case fair value of the stock is Rs.187 (2.4xFY22E ABV) and the bull case fair value is Rs.206 (2.65xFY22E ABV) over the next two quarters. Investors can buy the stock on dips to Rs.162-165 band (2.10xFY22E ABV) and add more on dips to Rs.146-150 band (1.90xFY22E ABV). At the LTP of Rs.176.9 it quotes at 2.28xFY22E ABV.
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