Morgan Stanley overweight on SBI; target of Rs 1850

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Morgan Stanley has rated State Bank of India as an over weighted stock  with a target price of  Rs 1850.

 

Morgan Stanley research reporton State Bank of India

 

Merger with State Bank of Saurashtra

 

Quick Comment:

 

Over the weekend, the boards of SBI and State Bank of Saurashtra decided to merge. SBS is currently 100% owned by SBI - the move will result in consolidation of operations.

 

SBS is a small bank - about 3% of SBI's assets and 2% of earnings.

 

However, this is an important move as we believe that it's the first step by SBI towards merging its seven banking subsidiaries with itself. Management had earlier said that it was looking at the option of merging all its banking subsidiaries with the bank itself (See our note on SBI, "The coming wave of corporate actions", dated 29 June 2007). This move will be a positive, in our view.

 

These seven subsidiaries have a combined market share of 8% - almost equal to that of ICICI Bank.

 

The merger will increase SBI's loan book by about 45%; moreover, it will reduce fragmentation in the Indian banking industry. Not only will the size of SBI's balance sheet go up meaningfully, these banks are doing fairly well in terms of earnings progression. In fact, in F2005-F2007 while SBI's EPS CAGR was about 3%, the EPS CAGR for subsidiaries was almost 23%. This merger will raise SBI's pro forma earnings by about 40%.

 

We are currently valuing banking subsidiaries of SBI at Rs342 per share of SBI.

 

We believe that the market is not giving full value to these subsidiaries, and the merger is likely to result in an increase in value ascribed to these subs by the market.

 

Operationally merger should not cause a problem -

 

SBI's banking subsidiaries had centralized their treasury operations with the parent's sometime back. The downside of the merger is that employees of SBS will get additional retirement benefits (SBI employees get three retirement benefits - pension, provident fund and gratuity; other SOE bank employees get only two of these).