14 July 2007

Initiating Coverage

STATE BANK OF INDIA (STABAN)

Striking the Right Cord: Unlocking Value
State Bank of India (SBI) is determined to gain meaningful market share by leveraging its size and resources in meeting rising credit demand. It is also enhancing operating efficiency and boosting fee-based income. We believe the bank can unlock tremendous value by diluting its stake in its subsidiaries and also grow its insurance arm aggressively. Consider SBI together with its highgrowth businesses, the countrys largest bank is trading at reasonable valuations. We initiate coverage on the stock with a performer rating.

Target price Rs 1666 Potential upside Time Frame Potential upside9-12 months 13% 11% Time frame 12 months Kajal Jain kajal.jain@icicidirect.com Chirag J. Shah chirag.shah@icicidirect.com

Current price Rs 1500

PERFORMER

INVESTMENT RATIONALE
Robust economy presents mega opportunities: India's economy is on the fulcrum of an ever- increasing growth curve with positive indicators such as a stable 8-9% annual growth rate. With a network of over 14,000 branches and 87% of its business covered under core banking solution, SBI is well poised to meet the countrys growing corporate, retail and infrastructure credit demand. Improving operating efficiency, boosting fee income: SBI has been continuously improving its operating efficiency with the cost-to-average assets ratio declining from 2.46% in FY06 to 2.23% in FY07. It is also raising its thrust on non-interest income, which formed nearly 30% of total income in FY07. Tremendous value in subsidiaries, insurance arm: SBI Life insurance is one of the fastest growing private sector players and offers an indirect way to take exposure in this booming sector. SBI can dilute its stake in subsidiary banks and earn profits thereby increasing its Tier I capital also. We believe that if SBI dilutes its stake in listed/unlisted subsidiaries, value unlocking will be substantial. NII & EPS trend
250.00 200.00 150.00 100.00 50.00 0.00 2005 2006 2007 2008E 2009E NII (Rs bn) 120.00 100.00 80.00 60.00 40.00 20.00 0.00

EPS (Rs.)

Stock metrics
Promoters holding Market Cap 52 Week H/L Sensex Average volume 59.73% Rs 81608 crore 1760 / 684 15272 5,30000

Valuations
At the current price of Rs 1500, the stock trades at 1.3x its FY09E adjusted book value (ABV), excluding value in subsidiaries (Rs 605 per share), and 8.5x its FY09E EPS of Rs 110.3. Factoring in an expected 7% equity dilution in FY08, we expect the bank to maintain its RoE at around 15%. Historically, the stock has traded at lower valuations compared to private sector banks mainly on account of its declining market share and public sector status. However, with the bank becoming more proactive in recapturing market share and concentrating on highgrowth businesses like insurance, we believe on a standalone basis, the stock would trade at least 1.5x its FY09E ABV, giving us a fair value of Rs 1062. Adding the subsidiaries value of Rs 605 per share (including SBIs stake in associate banks and other non-banking subsidiaries), we get a target price of Rs 1666, an upside of 11% over a 9-12 month time frame.

Comparative return metrics

Stock return SBI PNB Canara Bank HDFC Bank 3M 58.% 21% 42% 17% 6M 36% 10% 4% 15% 12M 112% 62% 40% 51%

Exhibit 1: Key Financials

Year to March 31 Net Profit (Rs. Bn) EPS (Rs) % Growth P/E (x) Price/Book (x) Price/Adj. Book (x) Gross NPA (%) Net NPA% RoNA (%) FY06 44.1 83.7 21.9 17.9 3.5 3.2 3.9 1.9 0.9 FY07 45.4 86.3 3.0 17.4 3.0 2.8 2.9 1.6 0.9 FY08E 51.5 91.4 6.0 16.4 2.5 2.3 2.6 1.4 0.8 FY09E 62.1 110.3 20.7 13.6 2.1 2.0 2.3 1.1 0.9

2000 1500 1000 500 0

Absolute Sell

Target Price

Absolute Buy

Source: Bank, ICICIdirect Research

ICICIdirect | Equity Research

M a r-05 M a y -05 Ju l-05 S e p-05 N o v -05 Ja n -06 M a r-06 M a y -06 Ju l-06 S e p-06 N o v -06 Ja n -07 M a r-07 M a y -07
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Company Background
SBI is the largest commercial bank in India. The bank was formed under an Act that was accordingly passed in parliament in May 1955. Later, the State Bank of India (Subsidiary banks) Act was passed in 1959, enabling the State Bank of India to take over eight former state-associated banks as its subsidiaries (later named associates). SBI plays a vital role in providing working capital and term finance to the Indian industry. Due to its large network of branches, SBI has been able to garner a large chunk of deposits from the rural sector. It has also got the largest overseas network. That is the reason as to why the bank has been the largest banking institution (assets, deposits, branches and employees) in the country. The bank also has various other interest in the financial services arena i.e. interest in Life insurance, Capital Markets, Cards and Factoring. The bank has wide international presence which it runs through its International Banking Group (IBG) that has a network of 70 overseas offices spread over 30 countries covering all time zones and which contributes 7% of total business for SBI. The bank has also explored inorganic route in the recent past where it acquired PT Indomonex bank in Indonesia. The bank on a standalone basis has a strong branch network of 9517 branches as on March 2007. The Banks assets have grown up to of Rs.500000 crore and the total business of the bank crossed Rs.700000 crore. For FY07 the bank posted a NIM of 3.20% and a ROA of 0.84%. The bank also witnessed a growth of 3% in PAT to Rs. 4541 crore. On consolidated basis, groups net profit grew 15.1% y-o-y to Rs.6365 crore. The amendment of the SBI Act by the parliament has thrown a lot of positives for the group such as for SBI, the positive factor is that it can reduce its stake in the subsidiaries and generate profit, which it can then use for its Tier-I capital. The parent will also not have to provide capital for its subsidiaries. This will give relief for capital adequacy. The changes will also facilitate SBI to split the shares of its subsidiaries. Banking Subsidiaries
-State Bank of Bikaner & Jaipur -State bank of Travancore -State Bank of Mysore Unlisted: -State Bank of Indore -State Bank of Hyderabad -State Bank of Patiala -State Bank of Saurashtra

Promoter & Institutional holding trend

70% 60% 50% 40% 30% 20% 10% 0% Q1FY07 Q2FY07 Q3FY07 Q4FY07 Promoter Holding Institutional Holding

State Bank
Group

Listed:

Non Banking Subsidiaries SBI Capital Markets SBI DFHI SBI Life SBI Funds Management SBI Factors SBI Cards

International Banking Group

Exhibit 2: Dominant corporate and retail banking franchise

SBI Group Share Total Business SBI 25%

SBI's Share Foreign Exchange

SBI Group's Share Government Transactionas

SBI 35%

SBI 67%

Source: Bank, ICICIdirect Research

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Investment Rationale
Economic growth presents enormous opportunities
India's economy is on the fulcrum of an ever-increasing growth curve. With its manufacturing and services sector on a searing growth path, Indias economy may soon touch the coveted 10% growth mark. The country is poised to see massive investments in infrastructure (roads, power), real estate (IT offices, retail malls, SEZs and residential buildings) and significant capacity additions in manufacturing industries like automobiles, petrochemicals, cement, etc. According to estimates, a whopping Rs 450,800 crore would be spent on infrastructure projects during the 10th and 11th five-year plans. SBI is the leader amongst Indian banks in terms of asset size with the largest network of over 14,000 branches. Further, 87% of its business is covered under core banking solutions. The bank is well poised to meet the countrys growing corporate, retail and infrastructure credit demand. Its can leverage its size to fund huge investments and future merger and acquisition deals too. The bank has also unveiled plans to raise over Rs 50,000 crore through debt and equity over the next 3 years to tap the growing credit opportunity in India. Currently, Indias loan-to-GDP ratio is still low at 41% compared to other emerging economies. This provides enormous scope for the Indian financial services sector. Exhibit 3: Loan to GDP Ratio
Loan-to-GDP Ratio
Hong Kong Taiwan China Malaysia Singapore Thailand Korea Indonesia India 0% 20% 21% 41% 40% 60% 80% 100% 120% 140% 160% 76% 75% 121% 115% 112% 110% 145%

Huge Infrastructure, corporate and retail credit demand to provide growth impetus.

Source: ICICIdirect Research SBI has finally begun leveraging its wide distribution network and size to gain meaningful market share. The bank's substantial number of branches in rural areas makes SBI even more competitive to tap the huge business opportunity of micro financing and rural credit. New initiatives like retail and small loan factories, technology improvements and progressive branding are all expected to give the bank the necessary flexibility and agility in an increasingly competitive field. Its credit growth has been in line with that of the banking sector. After declining consistently for the last few years, its market share has stabilised at around 15- 16% during last six months. Advances surged 29% y-o-y to Rs 33,7340 crore in FY07. We expect its loan book to grow at 23.5% in FY08E and 17% in FY09E to Rs 487,560 crore on the back of its suitable positioning to reap the benefits of India growth story.

Existing branch network to give further boost to the overall business landscape

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Exhibit 4: Credit Growth of SBI vis--vis industry

(Rs. In Crs.)

2500000 2000000 1500000 1000000 500000 0 2002 2003 2004 2005 2006 2007

40% 30% 20% 10% 0%

Industry

SBI

Industry Growth

SBI Growth

Source: Bank, ICICIdirect Research

Increasing market share, improving operating efficiency

The management is focused on improving its market share in both deposits and advances. It has adopted a multi-pronged approach to achieve this including de-risking its loan portfolio, mobilising resources and boosting feebased income.

De-risking its loan portfolio, increased focus on SME and retail sectors
SBI has got a diversified credit portfolio making it less vulnerable to risks associated with any one sector. However, with its increasing focus on the small and medium enterprise (SME) sector and mid-sized companies, the chances of higher slippages and consequently higher loan loss provisioning cant be ruled out. As of March 31, 2007, the share of retail advances to total advances was 21.5%. Retail sector credit has grown 20% y-o-y and exposure to housing sector has fallen from 12% to 11% of total portfolio. SBI will continue its thrust towards SMEs and retail for higher yields leveraging its large-scale rural presence. Exhibit 5: Break up of Loan Portfolio
Others International Food Housing Agriculture SME(Others) SME(Priority Sector) Mid Corporates Top Corporates 11% 12% 8% 7% 3% 4% 11% 11% 11% 11% 11% 12% 10% 10% 10% 10% 25% 23% Supporting tommorow's winners 2006-07 2005-06 Less Vulnerable to Housing Default

Market share loss to be arrested with an upward bias

Source: ICICIdirect Research 4|Page

Mobilising resources to fund balance sheet growth

The bank plans to raise funds amounting to Rs 12,000 -15,000 crore in FY08 through a combination of equity (we assume equity component at around Rs 5,000 crore) and debt. We have factored in equity dilution to the extent of 7% assuming necessary approvals from Parliament will be received to reduce the government stake below 59%. The bank will also be raising funds through Tier II bonds and debt thereby increasing costs. The overall cost of funds is expected to rise further to 5.4% in FY07 from the current 4.96%. But on an overall basis, the growth in the cost of funds for SBI has been lower than most others. In the past, SBI had surplus liquidity that supported its high credit growth despite IMD redemptions. This is one of the reasons why SBI lagged the industry in deposit growth. We believe the advantage of excess SLR is over and the bank will have to grow core deposits and other debt instruments to raise resources. Deposits grew at 14.6% y-o-y in FY07, which was lower than the industry average. The reason was the high base and dip in SBIs market share. In FY06 also, growth in deposits appeared to be slower at 3.5% on account of redemption of IMD deposits of Rs 23,014 crore. If we were to exclude the IMD deposits, growth was 9.8%. With excess SLR lowering to nearly 27% in FY07, SBI will now onwards need to rely on bonds and debt to fund its balance sheet growth. We expect deposits to rise 17% and 13.3% in FY08E and FY09E respectively, but still lower than expected deposits growth in industry of around 20%. Exhibit 6: Deposit Growth of SBI Vis--vis industry
Redemption of IMD in FY06 leading to lower deposit growth

Huge Funding plans of Rs. 50000crs. in next three years to fuel growth

3000000 2500000 (Rs. in Crs.) 2000000 1500000 1000000 500000 0 2002 2003

25.0% 20.0% 15.0% 10.0% 5.0% 0.0%

2004

2005

2006

2007

Industry

SBI

Industry Growth

SBI Growth
50%

Exhibit 7: CASA of PSBs vs. SBI

Source: Bank, ICICIdirect Research The share of retail deposits is rising which shows SBI has refrained from raising bulk deposits thereby lowering the cost of funds. Bulk deposits form nearly 17% of total deposits. SBI is not expected to increase its branch network aggressively and is expected to leverage the current extensive network of over 9.000 branches. We expect CASA deposits to remain stable at current levels of 43-44% for the next couple of years. Considering, the large balance sheet size of Rs 566,500 crore, CASA level of 43% is also huge. There is only one PSU bank namely PNB that is above SBI in terms of higher CASA as on March FY07. Cost of deposits have grown from 4.57% to 4.79% in FY07 and is expected to rise further to 5.03% by FY09E.

40%

30%

20%

10%

BOB

Canara Bank

IOB

OBC

PNB

SBI

2005-06 2006-07

Source: ICICIdirect research 5|Page

Exhibit 8: Trends in CASA & Cost of Deposits

5.5% 44% 44% 5.0% 43% 43% 42% 4.5% 42% 41% 4.0% 41% 40% 40% 3.5% 2005 2006 2007 2008E 2009E 39%

CASA

Cost of Deposits (LHS)

Source: Bank, ICICIdirect Research

Margins to remain stable

The yields on average assets are expected to rise on expanding balance sheet due to recent rate hikes. Further the cost of funds is also increasing. We expect the banks net interest margin (NIM) to stabilise at 3%. Initially, we expect a dip from current 3.2% to 3.04%in FY08E and then expanding another 4 bps in FY09E. Net interest income (NII) is expected to grow at a CAGR of 14% during FY07-09E to Rs 20,744 crore. Exhibit 9: NIMs expected to stabilize

Scale advantage to give pricing power and stabilize margins

250 200 (Rs. in bn) 150 100 50 2003 2004 2005 2006 2007 2008E 2009E

3.3% 3.2% 3.1% 3.0% 2.9% 2.8% 2.7%

NII(Rs.bn) - L.H.S

NIM's - R.H.S

Source: Company, ICICIdirect Research

Enhancing fee-based income

The banks fee-based income has grown at a CAGR of 13% over FY03-07 and we expect it to continue growing at a CAGR of 13% over FY07 09E to Rs 6,134 crore. We believe fee-based income will get a boost as the bank intensifies cross selling through its extensive branch network. SBI Life also gives corporate commission on insurance sales to the bank, which generates fee income too. Earlier about 6,000 branches were used for selling which is expected to go up to all its branches generating more fee-based income. SBI, which roughly accounts for one-fifth of the Indian banking industry, is also planning forays into new businesses such as general insurance and pension funds, which will give further boost to non interest income. SBI has the largest international presence among Indian banks. Going forward, we expect this presence to generate good fee income and garner deposits too.

Cross selling coupled with extensive branch network to boost fee income

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Aggressive marketing and brand re-positioning should help SBI generate higher fee income. In FY07, fee-based income rose to Rs 4,805 crore from Rs 3,996 crore, registering a 20% y-o-y growth. During the last five years, overall non-interest income has grown at a CAGR of 7% and we expect it to grow at a CAGR of 9% over FY07 09E. Non-interest income accounted for 31% of the banks total net income in FY07 and is expected to stay between 30-31% during the next couple of years. Exhibit 10: Increasing Focus on Core Business
250 200 Rs. bn 150 10 100 50 2005 2006 2007 2008E 2009E 5 20 15 Rs. bn

Net Interest Income

Non Interest Income

Trading Gains

Source: Bank, ICICIdirect Research Going forward, we expect income from trading to decline. Treasury losses are believed to be tapped as any major rise in yields is not expected due to stable inflation and steady demand and supply of government securities (GSecs). With new accounting policy for netting of amortization in investments from other income rather than including in provisions, reported other income looks subdued. However, we have continued with old system in order to show true picture of increasing non-interest income.

Greater operating efficiency

SBIs cost-to-income ratio is showing an improvement on account of stable employee expenses. Its cost-to-income ratio has fallen from 50.9% in FY06 to 50.3% in FY07 and is expected to go below 48% by FY09E. SBI is losing about 7,000 8,000 employees every year, which means over 35,000 employees in the next five years, whereas addition is very minimal. Employee expenses are estimated to show a nominal rise of 3 - 4% annually over the next 3-4 years. SBIs operating expenses to average assets ratio has fallen from 2.46% to 2.23% y-o-y and with increasing efforts to improve operational efficiency we believe it to fall below 2% by FY09E. We have assumed 8% CAGR over FY07-09E in overall operating expenses. Exhibit 11: Improving operating efficiency
0.8 0.6 0.4 0.2 0 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 0.035 0.03 0.025 0.02 0.015 0.01 0.005 0

Conscious efforts in reducing the number of employees to bring down operating expenses

Operating expenses/ Total net income %

Operating expenses/ Avg. assets %

Source: Bank, ICICIdirect Research 7|Page

Healthy asset quality

Gross and net NPAs as a percentage of advances have fallen to 2.92% and 1.56% respectively as of March 31, 2007 from 3.61% and 1.88% as of March 31, 2006. SBI is the largest bank and has largest asset book. We have factored in an increase in slippages in future estimates as fresh NPAs are expected under the rising interest rate scenario. We estimate gross NPAs at 2.33% in FY09E. The banks loan loss provision ratio is currently 46.3% and is projected to go up to 52% by FY09 thereby bringing net NPA levels to 1.11% by FY09E. Exhibit 12: Declining NPAs and rising loan loss coverage ratio
6.5% 5.5% 4.5% 3.5% 2.5% 1.5% 0.5% 2005 2006 2007 2008E 2009E 0.61 0.51 0.41 0.31 0.21 0.11 0.01

(Rs.in bn)

Gross NPA(%) Slippages(R.H.S)

Net NPA(%) Loan loss coverage ratio

Source: Bank, ICICIdirect Research

Equity dilution in H2FY08 to shore up Tier I CAR

The bank's capital adequacy ratio (CAR) at the end of March 31, 2007 was 12.34% with Tier I CAR at 8.01%. During H2FY08, the bank intends to undertake a further equity dilution, which we have assumed at 7%, in order to bolster its Tier I CAR. The fresh infusion of capital should help the bank grow its balance sheet size at a CAGR of 15% over FY07-09E to Rs 116,789.3 crore. Total assets have grown at a CAGR of 11% during last 5 years. Exhibit 13: Maintenance of adequate CAR
14% 12% 10% 8% 6% 4% 2% 0%
2005 2006 Tier I 2007 Tier II 2008E CAR 2009E

Follow on Public Offering of Rs. 5000 crore likely in H2FY08

Source: Bank, ICICIdirect Research

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Tremendous value in subsidiaries, insurance arm

Banking subsidiaries opportunity for unlocking value
SBIs seven associate banks had a market share of 7.52% in deposits and 7.56% in advances as at end FY07. We value the banking subsidiaries at Rs 269 per share of SBI based on FY09 estimates. We have valued its listed subsidiaries at current market cap, whereas unlisted subsidiaries are valued at 1x FY09E networth. The Lok Sabha gave its nod to SBI to reduce its equity stake in its seven subsidiary banks to 51%. The SBI (Subsidiary Banks) Act, 1959 amendment bill intended to bring SBI subsidiaries on par with other national banks and help them raise capital for meeting CAR norms under Basel II requirements. SBI can dilute its stake in Subsidiary banks and earn profits thereby increasing its Tier I capital also. We believe in case SBI decides to dilute the stake in listed/unlisted subsidiaries, huge value will be unlocked for SBI. b Exhibit 14: Details of banking subsidiaries

State Bank of Bikaner & Jaipur State Bank of Travancore State Bank of Mysore State Bank of Indore State Bank of Hyderabad State Bank of Patiala State Bank of Saurashtra

SBI's Opex / Avg Stake Assets 75% 1.92% 75% 1.48% 92% 1.69% 98% 1.29% 100% 1.41% 100% 1.19% 100% 1.95%

ROA 0.9% 0.9% 1.1% 0.9% 1.1% 0.8% 0.6%

ROE 20.0% 22.3% 24.0% 17.3% 21.7% 15.5% 10.5%

NIM's 3.4% 3.2% 3.1% 2.6% 3.0% 2.5% 3.0%

Business Branches Total 49246 56058 38784 35458 71227 68233 22284

CAR

Source: ICICIdirect Research New Holding company via NBFC route on the anvil The banks management has articulated its intention of forming a holding company (NBFC) and placing SBI Life and SBI AMC subsidiaries. It also plans to divest 10% of the holding company to strategic investors. This will help the bank in two ways. First, it will enable the fair valuation of the AMC business and the life insurance venture (as was clearly visible from the creation of ICICI holding co. where the company was valued at half the market capitalization of the parent). Secondly, it will reduce the burden of infusing fresh capital to fuel the growth of the life insurance venture. The capital required by the insurance arm for the current fiscal is estimated at Rs 500-600 crore. The plans are at a conceptualization stage and will take time to materialise. Exhibit15: Non-banking subsidiaries and joint ventures Value Per SBI's Stake PAT 2007 Share 86% N.A. 25 67% 53.3 12 63% 29.8 18 70% 13.1 1 60% 91.2 74% 3.8 25% N.A FY09E Total Rs. 3 265 12 336

844 12.9% 704 11.7% 642 11.5% 443 11.8% 949 12.5% 763 12.4% 431 11.8% FY09ETotal

Value per Tier I share of SBI 7.8% 29 7.6% 28 6.6% 40 6.7% 26 8.3% 67 8.4% 57 8.7% 21 269

Non Banking Subsidiaries SBI Caps SBI DFHI SBI Funds SBI Factors SBI Cards & Payments Services Pvt. Ltd. SBI Life Insurance Company Ltd. Stake in UTI AMC Source: ICICIdirect Research

Associate Partner ADB (4.69%) & other banks (22.46%) Societe Generale SIDBI (20%) & Union Bank of India (10%) GE Capital Cardiff

9|Page

SBI is also trying to harness the big opportunity in the pension funds management business, which it will operate through a subsidiary. The pension funds business looks attractive, as all banks cannot enter this segment because of the high entry barriers, which the RBI has prescribed recently. The possibility of merging all the associate banks together seems to be a difficult proposition. SBI Life Insurance In India, life insurance premium penetration is still very low at 2.5% of GDP whereas it is much higher in other countries. In FY07, SBI Life was one of the fastest growing private sector life insurance companies after Reliance Life. SBI Lifes gross written premium stands at Rs 2,928 crore and grew 172% yo-y in FY07 and 123% in FY06. APE (Annualized premium equivalent) overall business grew from Rs.494 crore to Rs.1804 crore. APE has grown at extraordinary 264% in FY07 to Rs.1804 crore. We expect the APE to grow atleast 121% in FY08E and 69% in FY09E to Rs.3984 crore and Rs. 6718 crore respectively. Valuing the company at 20% NBAP margin and 15 times its NBAP, we get the valuation at Rs. 14,913 crore (USD 5bn) for FY09E. This places the value at Rs.265 per share of SBI. Exhibit 16: Valuation of SBI Life Insurance FY2009E FY2008E FY2007 7972 5012 2928 59 71 172 6718 3984 1804 69 121 264 20% Valuation multiple 15% SBI's share 74% Value per share of SBI Source: ICICIdirect Research 14913 265 8844 157 20153 11951 5413 0 4006 76 1344 797 361

Low penetration of insurance and vast distribution network will help SBI spearhead the life Insurance boom

GWP Growth APE -new business % Growth NBAP Margin

Recently, Mr. O. P. Bhatt has stated that SBI Life Insurance is valued at Rs.28600 crore ($7bn) which converts SBI Life to a value of Rs. 375 per share. However, we have taken a conservative valuation based on FY09E which gives us SBI Lifes value at $5bn. Exhibit 17: Life Insurance premium to GDP (%)

Singapore Korea India Malaysia UK 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2.5% 3.6%

6.0% 7.3% Bound to Increase: Youngest Population in the world 8.9% 6.0% 7.0% 8.0% 9.0% 10.0%

Source: ICICIdirect Research

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SBI Lifes market share in private sector life insurance has risen from 8.1% in FY06 to 13.2% in FY07 depicting its high growth strategy. We expect SBI Life to continue gaining market share due to the reach it has got through the extensive branch network of over 14,500 branches of SBI and its subsidiaries. SBI Life enjoys the distinction of being only private player in the industry to have posted profits in two consecutive years. It posted a profit of Rs 3.83 crore and the total asset under management was Rs 4,741 crore as of March 31, 2007. It is also planning to make foray into the general insurance business. Exhibit 18: Rising market share of SBI
30 25 20 15

SBI Life is the only profit making company in the Indian private life insurance space

26 22

27 26

13 10 8 8

10 5 0

7 5 5 3 4 5 4 4 4 3 5 3 2 2

llia nz IC IC IP ru de nt ia l HD FC St an da rd

Su nl if e

M ut ua l

Yo rk

Vy sy a IN G

SB IL ife

AI G

Av iv a

M ax

Source: IRDA, ICICIdirect Research SBI AMC SBI AMC is making good profits since last couple of years. Funds under AUM grew at 28% in FY07 to Rs 16,873 crore. However, the industry grew over 41% during the same period. We have assumed SBI AMC to grow at 40% in FY08 and another 30% in FY09E whereas the industry is expected to grow at a faster rate. In India, mutual fund industry has yet got a long way to go as compared to its peer emerging economies and other developed countries before growth line tapers down. Net profit surged 60% in FY07 yo-y to Rs 29.8 crore from Rs 18.6 crore. Exhibit 19: Mutual Fund's AUM's as % of GDP

Ko ta k

FY06

FY07

M ah in dr a

Re lia nc e

Ta ta

Ba ja jA

N ew

Bi rla

Ol d

USA Korea India Brazil UK 0% 10% 20%

25% 8%

Mammoth opportunity
45% 31%
30% 40% 50%

SBI MF to benefit from the low base.

60%

70%

Li fe

74%

80%

AUM as % of GDP

Source: ICICIdirect Research 11 | P a g e

We believe SBI MF will nearly double its AUM by FY09E to Rs 30,709 crore. SBI AMC was ranked at 7th position in terms of AUM as at end FY07. We have valued SBI AMC at 5% its FY09E AUM, leading to its valuation at Rs 998 crore considering SBIs 65% stake. It thereby assigns a value of Rs.18 per share of SBI. Exhibit20: SBI AMCs AUM as compared to industry
450000 400000 350000 300000 250000 200000 150000 100000 50000 0 2002-03 2003-04 1.2 1 0.8 0.6

SBI AMC commands 7th position in terms of industry AUM

0.4 0.2 0 2005-06 2006-07

2004-05

AUM's Industry
AUM's Growth SBI (Y-o-Y)

AUM's SBI Funds

AUM's Growth All (Y-o-Y)

Source: AMFI, ICICIdirect Research RISKS & CONCERNS Sharp increase in interest rate concerns We believe the rise in interest rates could become a key risk factor, which may affect the banks stability in NIMs going forward. Pension liability to wipe of one years profit from reserves The expected pension liability to be provided for on account of revision in AS 15 on retirement benefits may bring a dip in reserves to the extent of as high as Rs 4,500 crore (if adjusted one time) and reduce its book value by Rs.80 per share. However, SBI and other banks may not exercise this option as this will lead to one time drastic fall in capital adequacy. Hence, as per the latest proposal to adjust the pension liability over 5 years, the banks profitability will be impacted by Rs 800-900 crore per annum. We have made a provision of the same in our estimates. Any negative macro economic factors to affect SBI Any downturn in economy will have a direct impact on SBI and its asset quality being the largest bank in the country. Loss in market share due to rising competition also remains a concern area for the bank

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FINANCIALS Net profit for FY07 grew by 3% y-o-y to Rs 4,541 crore. We expect net profit to grow at a CAGR of 17% over FY07-09E to Rs 6,214 crore and NII at a CAGR of 13% to Rs 20,677 crore. Core fee income grew 20% y-o-y to Rs. 4805 crores giving positive trend on the core income front. Non-interest income will continue to be one of key contributors in overall profitability with its share accounting for 31% of total net income in FY07. Currently, 75% of investment book is in HTM category with balance in AFS category with duration of less than 2 years. We therefore believe future MTM provisions to be under control. With net NPAs also gradually sliding down, we believe overall provisions remain between 0.7% to 0.8% of average assets. With 15% CAGR growth expected in huge assets base to Rs 7529 bn, we see RoA remaining stable at 0.8 0.9% during the next couple of years. Also, with issue of fresh capital expected in FY08, leverage is falling to below 18x going forward, putting pressure on RoE to remain at 15% levels. Exhibit 21: ROE Decomposition

Net interest income/ Avg. assets Non-interest income/ Avg. assets Net total income/ Avg. assets Operating expenses/ Avg. assets Operating profit/ Avg. assets Provisions/ Avg. assets Return on Avg. assets Leverage (Avg assets/ Avg equity) Return on equity Source: ICICIdirect Research

FY06 3.3% 1.6% 4.8% 2.5% 2.4% 0.9% 0.9% 18.4 17.0%

FY07 3.0% 1.4% 4.4% 2.2% 2.2% 0.8% 0.9% 18.0 15.4%

FY08E 2.9% 1.3% 4.2% 2.0% 2.2% 0.8% 0.8% 17.2 14.4%

FY09E 2.9% 1.3% 4.2% 1.9% 2.3% 0.8% 0.9% 16.5 14.5%

NIMs rose to 3.20% supported by advances growth of 29% and growth in deposits by a good 15% y-o-y. NIMs are stabilising at 3 3.1% with yield on average assets growing from 7.88% in FY07 to 8.17% in FY09E and cost of funds rising 4.96% to 5.4% during the same period. Exhibit 22: Return Ratios being maintained
1.1% 1.0% 1.0% 0.9% 0.9% 0.8% 0.8% 2004 2005 2006 2007 2008E 2009E 10% 5% 0% 25% 20% 15%

Return on net worth %

Return on avg. assets %

Source: ICICIdirect Research

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Valuation At the current price of Rs 1500, the stock trades at 1.3x its FY09E adjusted book value (ABV) excluding value in subsidiaries (Rs. 605 per share) and 8.5x its FY09E EPS of Rs 110.3. The above valuation makes the countrys largest bank available at good valuations. After factoring in an expected 7% equity dilution in FY08, we expect the bank to maintain its RoE at 15% levels. There still exists a huge gap between public and private sector valuations, which we expect to, decline gradually, particularly in case of larger PSU banks. SBI has got new top level management this year, which will be there for five years. This is another positive for the bank. Exhibit 23: M/cap to total assets
600000 500000 400000 (Rs. in Crs) 300000 200000 100000 0 HDFC Bank ICICI Bank PNB OBC SBI 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0

Indias largest bank available at reasonable valuations

Assets -L.H.S

M-CAP/Assets - R.H.S

Source: BSE, ICICIdirect Research Historically, SBI traded at lower valuations compared to peer private sector banks mainly on account of losing market and its public sector status. However, with SBI becoming more intense towards recapturing its market share and concentrating on other high growth businesses, we believe on standalone basis SBI to trade at least 1.5x its FY09E ABV giving us a fair value of Rs.1062. We add a subsidiary value of Rs. 605 per share (including SBIs associate banks and other non banking subsidiaries) as per exhibit giving us a target price of Rs.1666, an upside of 10% over a 9-12 month time frame. We rate the stock a performer. Exhibit 24: Peer group valuation Peer group comparison P/E UTI Bank 17.5 Canara Bank 5.9 PNB 7.2 SBI 13.7 SBI core banking (Standalone excl subs val) 8.6 Global peers Bank of China 12.1 1.9 ICBC 13.8 2.3 Bank of East Asia 13.0 2.1 Source: Bloomberg estimates, Consensus Estimates, ICICIdirect Research SBI, having the largest asset base in Indian economy is available at cheaper valuations compared to its global peers even after a rally in the stock in last one month. 2009E P/ABV 3.1 1.1 1.2 2.1 1.3 Focus on recapturing the lost market share and concentrating on new business prospects to justify the bank to trade at higher P/ABV of 1.5x on FY09E

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As depicted by P/ABV band, SBI is trading at 2.5x its FY07 ABV and 1.75x its FY09E ABV on standalone basis. As and when the PSU banks start getting re-rated, SBI being the leader should be the first beneficiary and below is the sensitivity analysis table. In case of Standalone bank being valued at 1.7x its FY09E ABV we get an overall target price of Rs.1790. But based on PSU banks valuation we have valued SBI at 1.5x its FY09E ABV giving us an overall target price of Rs.1666. Exhibit 25: Sensitivity Analysis if P/ABV multiple increases for core business

ABV
FY08E FY09E 708.2
991.48 1062.3 1133.12 1207.34

Multiple
1.4 1.5 1.6 1.7

610.7
854.98 916.05 977.12 1038.19

Source: ICICIdirect Research Exhibit 26: P/ABV Band -Valuation

1600 1400 1200 1000 800 600 400 200 0
200 3 5/1 6/ 200 4 5/1 6/ 200 5 5/1 6/ 200 6 5/1 6/ 200 7 5/1 6/

2.5x

2x 1.5x

0.5x

Source: ICICIdirect Research

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Profit and Loss Account

FY2009E 550.5 343.1 207.4 17% 88.4 61.3 4.1 23.0 295.9 86.2 50.4 159.2 59.0 100.2 38.1 62.1 21% FY2008E 465.7 288.5 177.2 10% 81.0 53.8 4.5 22.6 258.2 80.7 44.1 133.4 50.3 83.1 31.6 51.5 13% FY2007 394.9 234.4 160.5 3% 74.5 48.0 5.7 20.7 235.0 79.3 38.9 116.8 40.5 76.2 30.8 45.4 3% Rs. Bn FY2006 359.8 203.9 155.9 74.4 40.0 5.9 28.5 230.2 81.2 36.0 113.0 43.9 69.1 25.0 44.1

Interest Earned Interest Expended Net Interest Income % growth Non Interest Income Fees and advisory Trading Income and sale of Invt. Other income Net Income Employee cost Other operating Exp. Operating Income Provisions PBT Taxes Net Profit % growth

Balance Sheet
FY2009E Liabilities Capital Reserves and Surplus Networth Deposits Borrowings Subordinated Debt Other Liabilities & Provisions Total Assets Fixed Assets Investments Advances Other Assets Cash with RBI & call money Total 5.6 447.5 453.2 5770.2 520.8 288.2 499.8 7532.2 FY2008E 5.6 396.4 402.0 5093.5 424.9 221.7 463.1 6605.2 FY2007 5.3 307.7 313.0 4355.2 397.0 161.7 438.7 5665.6 Rs. Bn FY2006 5.3 271.2 276.4 3800.5 306.4 49.9 505.5 4938.7

29.2 1754.8 4875.6 271.0 601.7 7532.2

29.6 1587.2 4167.8 264.9 555.9 6605.2

28.2 1491.5 3373.4 252.9 519.7 5665.6

27.5 1625.3 2616.4 223.8 445.6 4938.7

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Ratios
FY2009E Valuation No. of Equity Shares (Rs. Bn) EPS (Rs.) BV (Rs.) BV-ADJ (Rs.) P/E P/BV P/adj.BV Div. Yield (%) DPS (Rs.) Yields & Margins Yield on average interest earning assets Avg. cost on funds Net Interest Margins Avg. Cost of Deposits Yield on average advances Profitabilty Interest expense / total avg. assets Interest income/ total avg. assets Non-interest income/ avg. assets Non-interest income/ Net income Net-interest income/ Net income Cost / Total net income Quality and Efficiency Credit/Deposit ratio GNPA% NNPA% RONW (%) ROA (%) 84.5% 2.3% 1.1% 14.5% 0.9% 81.8% 2.6% 1.4% 14.4% 0.8% 77.5% 2.9% 1.6% 15.4% 0.9% 68.8% 3.9% 1.9% 17.0% 0.9% 4.9% 7.8% 1.3% 29.9% 32.5% 46.2% 4.7% 7.6% 1.3% 31.4% 32.4% 48.3% 4.4% 7.4% 1.4% 31.7% 34.2% 50.3% 4.3% 7.5% 1.6% 32.3% 35.9% 50.9% 8.2% 5.4% 3.1% 5.03 9.1% 8.0% 5.2% 3.0% 4.90 8.9% 7.9% 5.0% 3.2% 4.79 8.3% 8.0% 4.9% 2.9% 4.57 7.6% 56.3 110.3 804.5 708.2 13.6 10.4 1.6 1.1% 24.0 56.3 91.4 713.7 610.2 16.4 13.6 2.1 1.0% 17.0 52.6 86.3 594.7 494.9 17.4 16.4 2.5 0.9% 15.0 52.6 83.7 525.3 432.0 17.9 17.4 3.0 0.9% 14.0 FY2008E FY2007 FY2006

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Key assumption growth ratios

FY2009E Advances Deposits Borrowings Operating expenses Fee income Trading gains Staff cost Effective tax rate Other assumptions Yield on average advances Cost of deposits Current Term Savings 17% 13% 23% 9% 14% -10% 7% 38% FY2008E 24% 17% 7% 6% 12% -20% 2% 38% FY2007 29% 15% 30% 1% 20% -3% -2% 40% FY2006 29% 4% 60% 16% 13% -67% 18% 36%

9.1% 0.0% 7.6% 3.5%

8.9% 0.0% 7.4% 3.5%

8.3% 0.0% 7.3% 3.5%

7.6% 0.0% 7.3% 3.5%

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Annexure on other non banking subsidiaries SBI DFHI, a primary dealer (PD), undertakes trading in government and non-government securities, in the debt market. For the period ended March 2007, the company had earned a PAT of Rs.53.25 crore. The company also diversified into profitable Non-SLR avenues resulting in better profitability. SBI holds 67.01% of their share capital while other nationalized banks hold 22.46%. All India Financial Institutions and Private Sector banks hold 5.84% and the Asian Development Bank holds 4.69% as on March 2007. SBI Cards & Payments Services Pvt. Ltd. (SBICPSL) SBI cards are in the 2nd position in the country under market share. The entity is a joint venture between GE and SBI. During the year 2006-07, the company issued 14.81 lakh additional cards and the total tally has gone upto 33.57 lacs. The company generated revenues of Rs.896.50 crore and PAT of Rs 58.77 crore an exuberant growth of 62% y- o- y. The bank has plans of reaching number one position in next 2 3 years. SBI Capital Markets Ltd (SBICAP) In 2006-07 the subsidiary substantially enhanced the scale of operations in the Project Advisory & Structured finance and Mergers and Acquisitions .It was ranked as no. 1 lead arranger in the Asia Pacific Region for the second consecutive year by both project finance international and Bloomberg. FY07 gross income stood at Rs.193.39 crore with number of branches rising to 34. SBI Factors and Commercial Services Pvt Ltd (SBI FACTORS) SBI Factors, a subsidiary of State bank of India (SBI) is one of the leading factoring companies in India. On the performance side, the asset level of the company increased by 33% i.e. from Rs. 919.36 crs to Rs.1225.18 crs in FY07.The number of clients also saw a rise of 48% which currently stands at 1106.The Company also witnessed 56% growth in total income and ended the year with a PAT of Rs. Rs.13.1 crs as against Rs. 10.67 in the last fiscal.

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RATING RATIONALE ICICIDirect endeavours to provide objective opinions and recommendations. ICICIdirect assigns ratings to its stocks according to their notional target price vs current market price and then categorises them as Outperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more; Performer: Between 10% and 20%; Hold: +10% return; Underperformer: -10% or more. Harendra Kumar Head - Research & Advisory ICICIdirect Research Desk, ICICI Securities Limited, 2nd Floor, Stanrose House, Appasaheb Marathe Marg, Prabhadevi, Mumbai 400 025 research@icicidirect.com harendra.kumar@icicidirect.com

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