Bank of India - Losing its charm?

BOI's loan growth came in better than we expected, but at the cost of margins. We cut our margin estimates to factor in the decline in low-cost deposits. However, the cut in target price is largely due to an increase in the cost of equity to 15%. We retain our Buy recommendation.

Strong loan growth comes as a negative surprise...
Loan growth in 1QFY09 accelerated from 32% in FY08 to 38.9%, much higher than the industry average of 25.9%. We believe loan growth will decelerate going forward and revise our loan growth estimate for FY09 to 20.0% from the earlier 22.5%. We believe firms with moderate loan growth will be able to maintain margins and asset quality as well as use capital efficiently.

... which was funded with high-cost deposits, leading to lower spreads
Reinforcing our view, the higher loan growth has come at the cost of margins. Spreads are down from 2.9% in 4QFY08 to 2.6% in 1QFY09. Low-cost domestic deposits declined from 35.5% at the end of March 2008 to 34.1% at the end of June 2008. With overseas loans continuing to outpace domestic loans, we now expect global low-cost deposits to decline from 30.5% of total deposits in FY08 to 29.9% in FY09. We also lower our FY09 net interest margin expectation for FY09 from 2.82% earlier to 2.72% now (2.71% in FY08).

Earnings momentum better than peers, but that seems at risk
Since FY06, the bank's high proportion of government securities in the held-to-maturity category and its focus on low-margin but profitable overseas business have helped it deal with a rising domestic rate environment. Earnings momentum and profitability were thus significantly better vs peers. We believe that momentum may be at risk due to the challenging macroeconomic environment. However, we largely retain our earlier net profit growth estimates for FY09 (7.5%) and FY10 (12.6%).

Maintain Buy recommendation; target price cut to Rs342.20
We maintain a Buy rating. The stock is trading at a premium to peers, but this seems justified considering the bank's superior profitability. We cut our core income estimates to factor in margin pressures, but lower loan-loss provisions offset this decline. The cut in target price is largely due to the increase in the cost of equity to 15%. At our target price, the stock would trade at 8.3x FY09F EPS and 1.8x FY09F adjusted book value.