hanging-discount.jpg

What do you do when your favourite chocolate in the super market is selling at discount?

Well, chocolates are my favourite so I would go and grab few more then usually for two reasons. First that I will save!! And the second reason is because I like them a lot.

We know many or almost most of the public sector banks are trading at huge discounts. But still not all of them are worth to invest. Many of them are in the cycle where their intrinsic values are trending down year after year. The very common reason we found are that those banks are repairing their Balance sheet and are highly leveraged and market is expecting a major financial haircut on their holding assets.

Many of us forget that markets are not always efficient. According to the ‘efficient market theory’, neither the information of a company is quickly disseminated and acted on in the stock market and neither all the market participants are both rational and profit motivated in this real world.  

Imagine that you purchase shares in a company and its price immediately starts declining. Many investors start thinking straight away that market knows something that they don’t. If you ask me then this assumption shoots from two things. The first is the possibility that not enough research has been conducted – which may be true. The second maybe shoots from the belief that every price movement means something.

I won’t go in more detail about how banks leverage and discuss about haircuts and efficient market. But have you thought about a business which in 2012 had invested only Rs 4,165 Crore and reported profits of Rs 652 Crore?

What is exciting about it? You would consider that it’s just a return of 16% on capital employed. This is very true.

But let me go little more in detail on how they generated these profits. They opened up their offices at various places and collected deposits from their customers around Rs 61,500 Crore and promised them that they will give them certain interest against those deposits.

For the whole 2012 year they paid interest of Rs 4,070 Crore against all their deposits. In other words they borrowed all of that big lump sum at 7%.

To make money from this business the management had to channel all of those deposits in certain way that they get returns of more than 7% on their investments. The other biggest challenge for the management is also to deploy that money in safe hands or ask for healthy collateral against their advances so that the risk of loosing capital is taken away.

Coming to the centre point of discussion, they managed to lend 49,244 Crore and invested Rs 16,670 Crore in various other projects. They managed to earn interest of Rs 6,291 Crore from lending business and Rs 599 Crore from other investments. This reflects 13% of interest income and 4% return on investments.

Looking at their six months results for financial year end of 2013 they managed to grow their deposits to Rs 64,800 Crore which reflects a growth of 14% compared to their last year half yearly results. Same time they managed to grow their lending books also by 14% compared to their last years half yearly results.

There are almost 1000 branches around the country and thousands of staff is being employed to run this business. After paying interest to their customers on their deposits, the second biggest cost is administration cost in this business.

We gauge this cost by the ‘cost to income’ ratio. This cost reflected 26% of their total income for the year end 2012 excluding the interest payments on deposits, taxes and provisions. For half year end 2013, this cost had shoot up to 28% but if we compare to last year half yearly results its has fallen down by 1%.

Well, all of this analysis and numbers belongs to SBBJ.  As per our platform, the shareholders of this business had contributed almost Rs 634 per share and are getting returns of 15% on their investment. We value this business in range of Rs 860 – 880 for the year end 2013 which reflects a discount of around 45%. We also do expect its intrinsic value for the year end 2014 to jump on 4 digits.

A piece of advice: do your own due diligence in regards to this business to gain confidence to invest in it. Value operations fund owns this business in its portfolio. You are also welcomed to share your insight on this business.