KARNATAKA BANK- Lowest valued private sector bank. Good potential for price appreciation.

KARNATAKA BANK is a 91 year old private sector bank, having headquarter at Mangaluru, Karnataka. It has good track record of profit and dividend payment. As on 31.03 2015, it was operating with 675 branches and 1000 ATMs spread across 21 States and 2 Union Territories. The bank has planned for further addition of 50 branches and 275 ATMs by March, 2016. The bank has 7382 employees, out of which 50% are recruited in last five years.

 Business figures of Karnataka bank for last five years are as under:

                                                                                                                  (Rs. in Crores)

Particulars	2010-11	2011-12	2012-13	2013-14	2014-15	Targeted in 2015-16
Deposits	27336	31608	36056	40582	46008	53500
Advances	17348	20720	25207	28345	31680	37500
Net Profit	204	246	348	311	451	-
EPS in Rs.	10.87	13.07	18.48	16.51	23.95	-
Dividend	30%	35%	40%	40%	50%	-
Net NPA	280	435	378	538	624	375
Net NPA in %  of Advances	1.62%	2.11%	1.51%	1.91%	1.98%	1%

As figures given in table above; Deposits, Advances and Net Profit of the bank are increasing over the years. Face value of the share is Rs.10/- and dividend payment has increased from Rs.3/- per share in 2011 to Rs.5/- per share in 2015. This shows management policy to reward shareholders.

Banks are in money lending business and a certain portion of Advances are not recoverable from the borrowers, which are called Non Performing Assets (NPA). As per banking regulator (RBI) guidelines, banks have to made provision from profits for these potential loan losses or NPAs. After provision of certain amount towards NPA remaining amount called Net NPA, for which banks have to make provision in forthcoming years. Banks can reduce Net NPA either by way of additional provision or by way of recovery. If any NPA fully recovered then banks reverse the provision amount to Profit & Loss account and it increases profit of the bank. Thus, lower NPA means higher profit and higher NPA means lower profit.

Here, I have discussed Net NPA, because Shri P. Jayarama Bhat, MD of Karnataka Bank has said in an interview that the bank is targeting Net NPA less than 1% by end of March 2016. Now a day’s most of the banks are facing increasing NPA problem, such statement of MD of the Karnataka Bank is surprising. It appears that the bank is confident to recover some big NPA accounts this year. If it really happened, this will result dramatic improvement in valuation of the bank.

VALUATION

On 10.07.2015, its share price was Rs.150/- trading at PE ratio of 6.26. Comparative valuation of Karnataka Bank with other midsized private sector banks is as under

                                (Rs. in Crores as on 31.03.2015)

Sr. No.	Name of Bank	Deposits	Advances	Net NPA	Net NPA % in FY 2014-15	EPS in FY 2014-15 (Rs)	Share price on 10.07.15 (Rs)	Trading PE ratio
1	Karur Vasya Bank	44690	36109	281	0.78%	38.11	474	12.44
2	Karnataka Bank	46008	31680	451	1.98%	23.95	150	6.26
3	Lakshmi Vilas Bank	21964	16513	303	1.85%	7.38	93	12.60
4	DCB Bank	12609	10465	106	1.01%	6.76	138	20.41
5	City Union Bank	20075	17965	233	1.30%	6.61	101	15.27
6	Federal Bank	70825	51285	373	0.73%	5.86	76	12.96
7	South Indian Bank	51912	37392	357	0.96%	2.28	25	10.96

In view of above data Karnataka Bank deserves for valuation of PE ratio of 12 to 15 range, if it will able to bring down the Net NPA below 1% as future guidance given by its Managing Director.

QIP

Karnataka Bank is planning of issue of share of 500 crores through QIP. I understand that bank will not issue shares in QIP at throw away price. It is in process of cleaning of balance sheet and QIP will be done after rerating of share price sometime in last quarter of this year at 20% to 25% above market price.

SHAREHOLDING

There is no defined promoter in Karnataka Bank. LIC is the largest shareholder having

5.41% shares. As per shareholding pattern on 30.06.2015, FII holding 22.28%, DII holding 9.19%, Bodies Corporate holding 9.24%, HNI holding 27.25% and remaining 32.04% share are with retail and other shareholders. Higher FII holding shows their confidence in the Karnataka Bank.

MERGER POSSIBILITY

After merger of ING Vysya Bank, Kotak Mahindra Bank emerged as fourth largest private sector bank after ICICI Bank, HDFC Bank and Axis Bank. Now, if Indusind Bank or Yes Bank wants replace fourth position of Kotak Mahindra Bank and strong presence in south India, Karnataka Bank is the best option for merger.

IDFC Bank has announced that it will start operations from October 2015 with 20 branches. If, it want to grow fast, increase retail business and compete with other private sector banks, it needs to increase branch network rapidly, which is not a easy task. Earlier, other new private sector banks have taken merger route to grow fast because it provide readymade branch network.

In case of any merger, FII and DII will support it, because they will get better valuation for their shareholding. Almost 50% staff is newly recruited in last five years and they are not member of old pension scheme, therefore resistance from staff will be less against merger.

Disclaimer: I am not a research analyst. Please take own decision after read the results, annual reports.