The shares of Canara Bank, India’s fourth-largest PSU Bank by loan book, have been on a bull run ever since the rebound after Covid-lows. From the lows of March 2020 to the recent highs in early June this year, the stock has grown about 8.5 times at a staggering CAGR of 66 per cent. This comes on the back of balance sheet clean-up, resulting in improvements in asset quality. The gross NPA (GNPA) ratio, which was at 8.8 per cent as of FY19 and peaked at 8.9 per cent in FY21, has declined to 3.7 per cent as of Q2 FY25. The return on equity (RoE) also has improved in due course from 1.4 per cent as of FY19 to 20.4 per cent (H1 FY25 annualised).

The stock has corrected from its recent peak of ₹128.25 (June 3, 2024) by 22 per cent and now trades at ₹100.40. At the said peak, the stock commanded a price-to-book value (P/B) multiple of 1.2 times. It now trades at a P/B multiple of 0.9 times. A conservative sum-of-the-parts (SOTP) valuation reveals a target price of ₹113, showing limited upside. At this price, the P/B multiple (on a consolidated basis) works out to 1x.

The standalone banking business constitutes 93 per cent of the target price and we have valued it at a conservative 1x P/B. This is because PSU peers, such as SBI, have better asset quality metrics for a similar RoE. SBI trades at a P/B multiple of 1.6 times with an RoE of 21.8 per cent (H1 FY25 annualised) and a GNPA ratio of 2.1 per cent.

Other key group entities included in the SOTP valuation are Canara Robeco AMC, Canara HSBC Life Insurance and Can Fin Homes. The AMC and life insurance entities are smaller compared with their key listed peers. Hence, their multiples in the SOTP valuation are assigned at a 30 per cent discount to the average multiples of their respective listed peers. Can Fin homes is valued on an actual basis, as it is a listed entity. A 30 per cent holding company discount is ascribed to all the group entities.

The bank recently announced that it has received regulatory clearances for divestment of 13 per cent and 14.5 per cent respectively in its AMC and life insurance entities. Per regulations, the bank is supposed to bring down stake in these entities to under 30 per cent by October 2029 through IPOs.

Balance sheet clean-up

The loan book constitutes 19 per cent retail loans, 24 per cent agriculture loans, 14 per cent MSME loans and corporate loans – 43 per cent.

Like its PSU peers, the bank has streamlined its underwriting standards and has cleaned up its balance sheet of legacy asset-quality issues. These with respect to the corporate portfolio are noteworthy. The GNPA ratio of the corporate book was at 12.6 per cent in FY19. It has been brought down to 3.7 per cent as of Q2 FY25. This has been made possible by increasing credit to quality borrowers. The share of loans advanced to borrowers rated A and above has been taken up to 78 per cent as of Q2 FY25 from 66 per cent as of FY19. There has been an improvement in the GNPA ratio of the rest of the book as well. Retail/ Agri/ MSME GNPA ratios as of FY19 – 1.8 per cent/ 5.5 per cent/ 9.6 per cent have improved to 1.1 per cent/ 3.7 per cent/ 7.7 per cent as of Q2 FY25.

Going forward

While asset quality was focused on, growth wasn’t left behind. Between FY19 and FY24, the banking system (all commercial banks combined) grew its advances and deposits at CAGRs of 12 per cent and 11 per cent respectively. Canara Bank surpassed the system-level growth with CAGRs of 17 per cent each.

In H1 FY25, the system-level growth in advances and deposits has been 13 per cent and 12 per cent respectively. But the same for Canara Bank has been 9.5 per cent and 9.3 per cent. The management notes that the slow growth in advances is primarily due to the shedding of low-yield corporate advances. Of such advances identified, the bank has withdrawn sanctions for about ₹40,000-crore worth loans. For FY25, the management has guided for a 11 per cent growth in loans, after accounting for such adjustments, with a focus on higher retail growth. Though this may be closer to what the system has grown so far, this fiscal, the bank’s peers SBI and Bank of Baroda (BoB) have guided for higher growth rates. SBI has guided for a 15 per cent growth, while BoB has guided for up to 14 per cent.

Deposit growth, too, has been sub-system-level growth, despite the bank’s cost of deposits being a good 50 basis points higher compared with its PSU peers. Though shedding of low-yield loans and its effect on slow growth in advances can be a short-term phenomenon, inability to mobilise deposits can weigh on the growth in advances in the long term.

For the full year FY25, the management has guided for a GNPA ratio of 3.5 per cent, net NPA ratio of 1.1 per cent, provision coverage ratio (PCR) of 90 per cent and credit cost of 1.1 per cent. The bank has either already achieved these metrics or is well poised to achieve them comfortably. The metrics as of Q2 FY25 stand as – 3.7 per cent, 1 per cent, 91 per cent and 1 per cent. However, the fact that such numbers are still on the higher side, compared with its peers such as SBI and BoB, justifies the absence of a premium valuation.

Given the track record of the management in achieving the guided figures, long-term investors can accumulate the stock on dips. At lower levels from current price, there is more comfort in the valuation and the stock offers higher margin of safety. There can be a positive rerating as and when the management executes its guidance.