Lakshmi Vilas Bank

Lakshmi Vilas Bank (LVB)

Buy

Target Price: Rs. 140

CMP: Rs. 101.4

Upside: 38%



Focus on consistent growth and improving asset quality
Investment arguments


Initiatives of the new management expected to provide growth momentum

Lakshmi Vilas Bank (LVB) was incorporated in 1926 and has operations largely in the southern states of India. In August 2010, the bank inducted a new management team consisting of senior executives from leading foreign and Indian private sector banks. This new team has plans to grow advances with an improved risk framework at LVB and focus on new verticals as well as the retail side of the bank. LVB has been witnessing improvement in its operating parameters as well as quality of assets over the last few quarters. The company’s Net Interest Margin (NIM) has improved from 2.5% in March 2009 to 3.8% in September 2010. Its provision coverage ratio has gone up to 70.1% in December 2010 from 26.3% in December 2009. RoA has improved from 0.7% in March 2009 to 0.9%* in September 2010. Also, RoE has improved from 11.5% in March 2009 to 12.6%* in September 2010. LVB plans to increase its branch network substantially (by 37%) by opening 100 new branches over the next two years. The new management also intend to keep their focus on micro and small and medium enterprises (MSME), which currently forms 36% of the total loan book. Setting up a housing finance company and improving overall efficiency would be key focus areas of the bank, going forward.



Significant improvement in asset quality improves conviction in the new management

LVB has witnessed considerable improvement in its asset quality over the last few quarters. The gross Non-Performing Assets (NPAs) have come down from 5.7% in December 2009 to 3.0% in December 2010. Similarly, the net NPAs have also fallen from 4.2% in December 2009 to 2.0% in December 2010. The new management has set a target for focussed reduction of NPAs as well as consistent and profitable growth. The new team is quite aggressive on the recovery front – the bank has sold a few NPAs and reportedly recovered Rs. 70 cr from these activities in the current quarter (Jan-Mar 2011). Consequent to these efforts, we expect the Net NPA to fall significantly below 2% by end of the current quarter. The bank aims to bring down its net NPAs to less than 1% over the next two years.



We expect consolidation of Old Private Sector Banks to continue

While the Old Private Sector Banks (OPSBs), like LVB, lack identifiable promoters, we firmly believe that the issue of new banking licenses are likely to be quite restricted. Further, we expect that even if new banking licenses are issued, it would take a minimum of 1-2 years for the new players to start and scale up their business. Hence, we believe there is further scope for significant consolidation in this space by means of either an outright takeover or by acquiring a sizeable equity stake. We expect LVB could be one of the beneficiaries of the expected further consolidation process.



LVB stock, available at an attractive valuation

LVB’s stock price has corrected by nearly 30% from its peak price of Rs.143/ reached in September 2010. At the current price, the stock is available at attractive valuations of 1.2x its FY12E Adj. BV of Rs.83.5/. An analysis of some of the recent M&A deals in the OPSB segment reveals that such deals were done at much higher valuations than what some of the old private sector banks, like LVB, are enjoying at present. The acquisition of Bank of Rajasthan, at 5.5x its book value, by ICICI Bank in May 2010, is a case in point. Prior to that, in 2008, HDFC Bank had acquired Centurion Bank of Punjab at 4.5x its book value. We believe that LVB might eventually be a significant beneficiary of anticipated further consolidation process in the OPSB segment.

Risk to our view

Any significant slow down in the industrial economy could increase its NPAs and thereby impact its profitability adversely.

Valuation and Recommendation

We believe that the medium to long-term prospects of the banking sector remain strong as India’s GDP is expected to grow at 8%+, over the next few years at least. This improved growth prospects augur well for the banking sector, which has enjoyed a credit multiplier of about 3x over GDP growth rate in the past. LVB, with a new management team in place, is witnessing improvement in its operational parameters and also in its asset quality. Considering LVB’s improving operational performance, attractive valuation and further opportunity for consolidation process in the OPSB segment, we recommend a BUY on the stock which currently trades at 1.2x FY12E Adj. BV of Rs.83.5/, with a fair value of Rs.140/, based on a valuation of 1.7xFY12E Adj. BV.