Buy Union Bank of India Ltd For Target Rs.60 - LKP Securities
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....corporate recoveries to improve credit quality
Post amalgamation of Andhra Bank & Corporation Bank into Union Bank of India, UBI today is a leading PSU bank with a network of over 9200 branches and over 11600 ATMs. The bank’s total business as of 2QFY22 stood at ₹15.5tn, comprising ₹9.1tn of deposits and ₹6.4tn of advances as of 30th September 2021. The bank has different lending verticals; retail, agriculture, MSME and corporate. The RAM (Retail, Agriculture, and MSME) contributes 60% of loan book while rest is corporate book.
2Q FY22 earnings has shown signs of recovery on the back of corporate recoveries, lower cost of funds and a healthy liability franchise. We expect UBI to emerge stronger by the end of this fiscal. The credit quality recovery in 2QFY22 was meaningful as absolute GNPA inched down (9% sequentially) driven by healthy recovery (DHFL) and write-offs. A healthy capital position (CET-1 of 10.4%) may keep the momentum going. Factoring ~7% advance growth, stable NIMs and lower credit cost; the bank may post 89% PAT growth in FY22E. An inexpensive valuation (0.35xFY24 Adj. BVPS) makes the stock rewarding factoring FY22/23 ROE of 8%/10%.
Investment Argument
Corporate recoveries to improve credit quality: While covid induced stress impacted the RAM segment, the first half of this fiscal has witnessed lower slippages and higher recoveries. Higher recovery/write-offs led to 96bps improvement in the GNPA ratio to 12.6% (as on 2QFY22). The overall restructuring pool for the bank stood at ₹214bn, 3.7% of loans with major contribution from Retail (45%) and corporate (30%).
Higher CASA traction to improve NIMs: The bank has maintained a cautious approach in credit off-take. However, the margins stood tall because of low cost deposits. Observing the annual trend of NIMs, we found gradual improvement in NIMs with consistent growth in CASA deposits. Moreover the CASA growth was marginally higher than overall deposit growth. On the back of moderate slippages, the interest reversal is likely to be at lower end. We estimate NIMs of 2.6% in FY22 v/s 2.2% in FY20. The yields on advances are likely to be stable at 11.7% with decreasing cost of funds at 4.4%.
Specific PCR stable at 67%. On the other hand, the overall SMA 2 ratio declined to 2.3% from 3.7% in the beginning of the year. A lower SMA pool and manageable restructuring indicates a lower stress formation. Management expects recoveries and upgrades of ₹60bn in 2HFY22, leading to a total of ₹160bn (2.7% of loans). This, coupled with the transfer of ₹80bn of identified accounts and ₹40bn worth of fraud accounts to NARCL (200bps of loans), should further bring down corporate/overall NPA. For FY22, management expects credit cost and delinquencies to be 2% and 2.5%, respectively. Hence, we estimate GNPA/NNPA of 8.7%/3.3% in FY24E from the current level of 12.6%/4.6%.
Credit to grow moderately; capital cushion satisfactory: Post amalgamation, we believe the credit growth to remain modest and estimate a CAGR of 7% for FY21-24E across all segments. The bank is well capitalised at CAR of 12.6% (Tier 1: 10.4%) as on FY21. With moderate credit growth and improving NIMs, the NII shall grow at a higher pace and so would PPOP. With lower credit cost for FY23/24E, we estimate a ROA/ROE of 0.7%/10% and 0.9%/12% for FY23/24E respectively.
Outlook and Valuation
Union bank reported healthy earnings, supported by recovery from the DHFL resolution as well as improvement in asset quality, aided by higher write-offs and strong recoveries/upgrades. However, loan growth to remain sluggish due to decline in corporate advances, while modest growth recovery is expected in the RAM segment. Overall, the management indicated asset quality would continue to improve, aided by moderation in the slippage trend and higher recoveries from stressed asset resolutions. Furthermore, SMA2 overdue declined to 2.3% of loans, while the restructured portfolio at 3.7% of loans. Thus, we estimate credit costs at 2.2%/1.9% for FY22/FY23E and ROA/ROE at 0.9%/11.7% by FY24E. We recommend BUY, with Target Price of ₹60 (0.4x FY24E ABV).
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