Assignment of Security Analysis and Portfolio Management

On

Fundamental Analysis

(Company: State Bank of India)

Submitted to Lovely Professional University

Submitted To: Submitted by:

LOVELY PROFESSIONAL UNIVERSITY

2008-10

About State Bank of India

State Bank of India (SBI) is the largest bank in India. The bank traces its ancestry back through the Imperial Bank of India to the founding in 1806 of the Bank of Calcutta, making it the oldest commercial bank in the Indian Subcontinent. The Government of India nationalised the Imperial Bank of India in 1955, with the Reserve Bank of India taking a 60% stake, and renamed it the State Bank of India. In 2008, the Government took over the stake held by the Reserve Bank of India.

SBI provides a range of banking products through its vast network in India and overseas, including products aimed at NRIs. The State Bank Group, with over 16000 branches, has the largest branch network in India. With an asset base of $250 billion and $195 billion in deposits, it is a regional banking behemoth. It has a market share among Indian commercial banks of about 20% in deposits and advances, and SBI accounts for almost one-fifth of the nation’s loans.

SBI has tried to reduce its over-staffing through computerizing operations and Golden handshake schemes that led to a flight of its best and brightest managers. These managers took the retirement allowances and then went on the become senior managers at new private sector banks.

The State bank of India is 29th most reputable company in the world according to Forbes.

Fundamental Analysis:

Fundamental analysis refers to the study of the core underlying elements that influence the economy of a particular entity. It is a method of study that attempts to predict price action and market trends by analyzing economic indicators, government policy and societal factors within a business cycle framework. The fundamental analysis of a company involves the following parameters:

1. Macroeconomic Analysis 2. Industry Analysis 3. Company Analysis

How does an investor determine if a stock is undervalued, overvalued, or trading at fair market value? With fundamental analysis, this may be done by applying the concept of intrinsic value. If all the information regarding a corporation's future anticipated growth, sales figures, cost of operations, and industry structure, among other things, are available and examined, then the resulting analysis is said to provide the intrinsic value of the stock.

To a fundamentalist, the market price of a stock tends to move towards its intrinsic value. If the intrinsic value of a stock is above the current market price, the investor would purchase the stock. However, if the investor found through analysis that the intrinsic value if a stock was below the market price for the stock, the investor would sell the stock from their portfolio or take a short position in the stock.

1. Macroeconomic Analysis:

� Change in rates by RBI:

Looking at the changing scenario, RBI keeps on changing rates such as Repo Rate, Reverse Repo Rate and Cash Reserve Ratio. These rates have a direct relation with Bank’s performance and in turn share prices are linked with bank’s performance. Thus, a change in these rates or even a speculation of change in these rates affects share prices.

� Global Analysis:

Any change in global economy or in other words, global changes also affects Indian economy. For example: The recession was first observed in USA and later on it caught its lead in other countries too. When it entered India, the share market crashed literally. It affected many banks as ICICI and others, resulting in loss of people’s confidence towards banks.

� Change in Governments Policy:

The government takes desired steps and keeps on reviewing its policies, rules, regulations and procedures. A change in FDI and FII inflow restrictions, entry exit barriers for foreign banks in India, EXIM regulations, change in Basel norms, etc form a part of important government policies. For example if government allows entry of foreign banks in India, then competition would rise, and it may happen that those foreign banks may outperform and leave our own banks far behind. Thus, some restriction would follow and this will definitely affect share prices.

� Effect of Inflation on banking operations: Several economists have found that countries with high inflation rates have inefficiently small banking sectors and equity markets. This effect suggests that inflation reduces bank lending to the private sector, which is consistent with the view that a sufficiently high rate of inflation induces banks to ration credit.

� Effect of monetary policy on Banking Sector:

Monetary policy affects banking sector in many ways. One way is through credit markets. Because of imperfect information, incomplete contracts and imperfect bank competition, monetary policy may affect banks’ loan supply. In particular, expansive monetary policy may increase banks’ loan supply directly (bank lending channel), or indirectly by improving borrowers’ net worth and, hence, by reducing the agency costs of lending.

2. Industry Analysis:

Life Cycle Analysis:

Bank plays an important role in the economic development of the country. The entire commercial and industrial activities are well knitted with the banks. One cannot imagine the cessation of the banking activities even for a day. There may be an economic crisis in the country if the banks stop functioning for some days. In the early days, the banking business was confined to receiving of deposits and lending of money. But the modern bankers undertake wide variety of functions to assist their customers. Banks are like any other business in that they produce goods and services to customers. Like any other businesses, their products have life cycles. Cheques are in a decline phase of their life cycle and use of cheques is declining rapidly and being replaced by electronic bill pay and debit cards. Internet Banking and Electronic Bill pay are in their growth phase as more and more customers are using these services. Cards or Cheque Cards are in their maturity phase as they are accepted by nearly everyone. So overall, the banking industry is in a GROWTH PHASE, as new measures are being adopted overtime so as to make transactions speedy and easy.

Porter’s five forces analysis:

1. Threat of New Entrants. The average person can't come along and start up a bank, but there are services, such as internet bill payment, on which entrepreneurs can capitalize. Banks are fearful of being squeezed out of the payments business, because it is a good source of fee-based revenue. Another trend that poses a threat is companies offering other financial services. Also, the possibility of a mega bank entering into the market poses a real threat.

2. Power of Suppliers. The suppliers of capital might not pose a big threat, but the threat of suppliers luring away human capital does. If a talented individual is working in a smaller regional bank, there is the chance that person will be enticed away by bigger banks, investment firms, etc.

3. Power of Buyers. The individual doesn't pose much of a threat to the banking industry, but one major factor affecting the power of buyers is relatively high switching costs. If a person has a mortgage, car loan, credit card, checking account and mutual funds with one particular bank, it can be extremely tough for that person to switch to another bank. In an attempt to lure in customers, banks try to lower the price of switching, but many people would still rather stick with their current bank. On the other hand, large corporate clients have banks wrapped around their little fingers. Financial institutions - by offering better exchange rates, more services, and exposure to foreign capital markets - work extremely hard to get high-margin corporate clients.

4. Availability of Substitutes. There are plenty of substitutes in the banking industry. Banks offer a suite of services over and above taking deposits and lending money, but whether it is insurance, mutual funds or fixed income securities, chances are there is a non-banking financial services company that can offer similar services. On the lending side of the business, banks are seeing competition rise from unconventional companies. Sony, General Motors and Microsoft all offer preferred financing to customers who buy big ticket items.

5. Competitive Rivalry. The banking industry is highly competitive. The financial services industry has been around for hundreds of years and just about everyone who needs banking services already has them. Because of this, banks must attempt to lure clients

away from competitor banks. They do this by offering lower financing, preferred rates and investment services. The banking sector is in a race to see who can offer both the best and fastest services, but this also causes banks to experience a lower ROA. They then have an incentive to take on high-risk projects. In the long run, we're likely to see more consolidation in the banking industry. Larger banks would prefer to take over or merge with another bank rather than spend the money to market and advertise to people.

3. Company Analysis:

Last Trade: 2,089.60

Prev Close: 2,009.25

Open: 2,025.00

Bid: 2099.00

Ask: 2100.00

Day's Range: 2021.00 - 2100.00

52wk Range: 894.00 - 1,935.00

Volume: 603,636

Avg Vol (3m): 511,585

Report card

Attribute Value Date

PE ratio 14.54 16/09/09

EPS (Rs) 143.67 Mar, 09

Sales (Rs crore) 17,472.76 Jun, 09

Face Value (Rs) 10

Net profit margin (%) 12.03 Mar, 09

Last dividend (%) 290 11/05/09

Return on average equity 15.74 Mar, 09

To determine the intrinsic value, as it is given, the projected EPS is 143.67 and P.E ratio is 13.62. Therefore, the intrinsic value is calculated as follows: Intrinsic value = Projected EPS * Appropriate PE Ratio

= 143.67 * 14.54 = 2088.96

Since the stock prices are expected to rise and there is not much difference between the intrinsic value and market price, it would be better to hold the stock, so as to have more profits. Despite a debilitating economic environment, State Bank of India exhibited a strong bottom-line for FY09. The Bank's FY09 net profit increased 35.5% yoy to Rs. 91.2 bn. While the growth in the first three quarters was led by NII, in Q4'09 it was dependent on other income. For the next few quarters, we foresee SBI’s bottom-line to be pressured by declining yields, higher cost structure, and larger provisioning-outlay required due to rising delinquencies. The stock currently trades at a P/B, which we believe is high considering the uncertainty regarding the quantum of the Bank’s delinquencies and the growth in SBI Life’s new-business premium. We see limited upside from current levels and therefore, downgrade our rating to Hold. State Bank has been recording relatively high Return on Equity ranging from 16% to 22% in earlier years -due to high financial leverage employed. There are only three levers for boosting ROE -Net Margin, Asset Turnover and Financial Leverage. In State Bank of India case, both Net Margins and Asset Turnover is lower than other banks. It is the higher Financial Leverage that has been boosting up Return on Equity for SBI -which is not a very good sign. However to its credit, FY09 financial leverage is down to a more conservative 15.74 still at much higher levels than other banks like HDFC Bank (11.58x), ICICI Bank (10.77x), or Axis Bank (12.52x).Besides Return on Assets has seen consistent gradual improvement over last 3 years to reach 1 percent -much better than ICICI Bank's (0.71%), comparable to Axis Bank's (1.16%), but falling much short of HDFC Bank's magnificent 1.42 percent.

References

From webpage:

• http://en.wikipedia.org/wiki/State_Bank_of_India

• http://www.finpipe.com/equity/fundanl.htm

• http://in.finance.yahoo.com/q/ta?s=SBI.BO

• http://money.rediff.com/companies/state-bank-of-india/14030001

• http://www.valuenotes.com/valuenotes/research/companyhome.asp?cn=45&fid=1

From Books:

Investment Analysis and Portfolio Management by Prasanna Chandra