Buy SBI; target Rs 1780: Sharekhan Research

India, July 02 -- Sharekhan Research has recommended buy rating on State Bank of India with revised target price of Rs 1780.

The Reserve Bank of India (RBI) has announced that it is going to transfer its 59.7% holding in State Bank of India (SBI) to the government for Rs 35,530 crore on June 29, 2007. The transaction is revenue neutral for the government, as the RBI would declare a special dividend of a similar amount to replace the amount paid by the government for the stake sale.

The SBI management has said that the bank will require to raise Rs15,000 crore of capital in FY2008; of this Rs 6,000 crore is likely to be in the form of equity and the balance as debt.

The current guidelines restrict SBI from diluting the promoter's stake below 55% and this would hinder the bank's capital raising plans. Hence the management is of the view that the follow-on offer would take place after the amendment to the SBI Act, most probably in December 2007.

SBI has plans to consolidate its insurance and asset management businesses into a separate non-banking financial company (NBFC). It also plans to sell a 10% stake in the NBFC to three to four investors and intends to list the arm in FY2009. All these would be significant value drivers going forward. The chairman of the bank has stated that he expects the valuation of the life insurance business to be around Rs 28,700 crore (USD 7 billion) while we have valued the same business at Rs 23,800 crore (USD 5.8 billion). Our valuation is lower considering the roadblocks that the bank is likely to face while unlocking the value in these investments, just as ICICI Bank is facing now.

After providing for the AS-15 impact (Rs 900 crore of extra provision per year from FY2008-12) our earnings estimates for FY2008 and FY2009 have reduced by 4% each. We have also introduced our FY2009 estimates. Based on the current market price of Rs 1,525 the stock is currently trading at 13.9x FY2009E earnings per share (EPS), 1.9x FY2009E stand-alone book value of Rs 813 and 1.4x FY2009E consolidated book value of Rs1,061. The stock has run up 54% in a span of the past three months. Hence in the near term there could be some profit booking and consolidation. However, we believe the bank has entered a sweet spot as a host of policy changes in the banking sector and for SBI could unlock significant value in the stock in the medium term. We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs 1,780.

Significant capital raising plans undertaken by SBI

SBI plans to raise Rs15,000 crore in FY2008. Of this Rs 6,000 crore is likely to be raised in the form of equity and the balance as debt. The current guidelines restrict the bank from diluting the promoter's stake in it below 55% and would hinder its capital raising plans. Hence the management is of the view that the follow-on offer would take place only after the amendment to the SBI Act, most probably in December 2007. The bank would need Rs 5,000 crore for Basel II compliance. As per the management the associate banks will need around Rs 8,000 crore by 2009. The insurance business would also require significant injection of capital as SBI aims for robust growth for its life insurance venture.

Alternate instruments to be preferred

Currently the holding of foreign institutional investors in the bank has reached the maximum ceiling. In order to get better valuations from the foreign investors the bank has requested the government to consider the issue of nonvoting shares. Again guidelines on the issue of preference shares are awaited. Since SBI's current capital adequacy ratio (CAR) is at 12.3% with Tier-I CAR at 8%, the bank prefers to wait and then decide on the instruments for the capital raising exercise. Some of the mid-sized public sector banks have already reached the 51% government threshold holding limit, hence some developments on alternate capital raising plans are expected which would trigger a re-rating in the public sector banking stocks.

Valuation and view

We have also introduced our FY2009 estimates. Based on the current market price of Rs1,525 the stock is currently trading at 13.9x FY2009E EPS, 1.9x FY2009E stand-alone book value of Rs 813 and 1.4x FY2009E consolidated book value of Rs 1,061. The stock has run up 54% in a span of the past three months. Hence in the near term there could be some profit booking and consolidation. However, we believe the bank has entered a sweet spot as a host of policy changes in the banking sector and for SBI could unlock significant value in the medium term. We maintain our Buy recommendation on the stock with a revised twelvemonth price target of Rs 1,780.

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