South Indian Bank:Ramdeo Agarwal’s multi-bagger stock?

When Ramdeo Agarwal, millionaire founder-partner of Motilal Oswal Financial Services Ltd, announced South Indian Bank as his newest stock pick for his investment portfolio, a lot of people took notice. Ramdeo Agarwal has an amazing reputation that precedes him. A CA by education, he co-founded Motilal Oswal Financial Services, a brokerage firm with a market capitalization of Rs. 2,392 crores. More importantly, Ramdeo Agarwal has built a solid reputation as a stock-picker. He has several multibaggers to his credit; the notable ones being Bharti Airtel, Hero Honda and SBI. The story about Bharti Airtel is particularly endearing because Ramdeo Agarwal candidly recounts that when he homed in on Bharti Airtel, he was severely doubted by his peers including founder-partner Motilal Oswal. But such was his conviction in Bharti Airtel that he not only held out but increased his holdings. The rest, as they say, is history and Ramdeo Agarwal joined the hallowed ranks of celebrity investors with the Midas touch.

So, when Ramdeo Agarwal announces to the World that he has invested in a stock, it is to be taken very seriously. Because, who knows, with his stock-picking skills, one may be looking at the next multi-bagger.

The first thing about South Indian Bank that must have attracted Ramdeo Agarwal is its’ size. South Indian Bank is a pint sized bank with a total market capitalization of only 2109 crores (compare that with (his other favourite stock) behemoth SBI’s Rs. 1,52,933 crores). South Indian Bank‘s total income in FY 2010 was Rs. 2,144 crores.

Its’ no secret that astute stock pickers like Ramdeo Agarwal, Rakesh Jhunjhunwala and Ramesh Damani prefer small and mid-cap stocks. Why? Simply, because when a pint sized company becomes a mid or large cap stock, your investment automatically becomes a multi-bagger! Rakesh Jhunjhunwala, the greatest Indian Investor, bared this secret when he candidly confessed his preference for small-cap and mid-cap shares as the surest way of latching on to multi-baggers.

Rakesh Jhunjhunwala fondly recollects how his investments in pint-sized companies like Karur Vyasa Bank and Praj Industries have yielded him crores and crores of profits!

But Ramdeo Agarwal knows as well as anyone else that mere size means nothing if it is not accompanied with high profitability.

So, how does South Indian Bank score on this front?

Well, the answer is that South Indian Bank is an extremely profitable bank. In the last twelve financial years, South Indian Bank has consistently reported Net Interest Margins (“NIM”) in excess of 3%. That’s quite an achievement given that there are not many banks that are able to match this level of profitability.

The other factor that affects profitability for banks is NPAs. South Indian Bank‘s NPAs were under control at 0.4% of the net advances in FY 2010 which was a dramatic improvement over last year’s 1.1%. Low NPAs obviously mean that South Indian Bank‘s profitability will rise.

The other noteworthy aspect of South Indian Bank is that its return on assets averaged about 1.1% in FY2010. This is also superior compared to the average ROA in the banking industry.

One word of caution must be noted here. In FY 2010, South Indian Bank‘s net profit growth was 20% while it has averaged 58% in the preceding three years. Well, this is not a matter of concern because the lower rate of growth was attributable to a one-time penalty of Rs. 33 crores that South Indian Bank paid. If one excludes the effect of this penalty, the result is that South Indian Bank‘s net profit shows a comfortable growth of 30%.

Ok, but the other question that Ramdeo Agarwal must have asked is about scalability of operations. After all, what good is profitability if it cannot be rapidly scaled up or ramped up?

Well, South Indian Bank doesn’t disappoint on this front either.

Though South Indian Bank operates primarily in south India, it has ambitious plans to extend its reach to other parts of India as well. South Indian Bank has a network of 580 branches at present. South Indian Bank plans to open 60 new branches in the near future.

Such new branches will obviously scale up the operations of South Indian Bank and meet what master investor Ramdeo Agarwal is looking for. For a bank, more branches simply mean more access to cheap current account and savings account (CASA) deposits. This obviously will enhance the lending capability of the bank and result in greater profits.

The other point worth noting is that Ramdeo Agarwal is extremely bullish about the banking sector. He has very strong logic to back his optimism on banks. He says that if the Indian economy is to grow at 7 to 9% over the next few years, the sector that will benefit the most is the banking sector. Makes sense! Also he points out astutely that competition in the banking sector is extremely restricted. The entry barriers for banks are set very high. RBI licenses to open new banks are hard to come by. The result: The existing banks will profit and laugh their way to the bank (!) he says.

It is precisely this kind of foresight and compelling logic that has made Ramdeo Agarwal join the ranks of legendary investors.

One point that Ramdeo Agarwal is always wary about is the downside. He is always at pains to emphasize that one must always preserve capital. Put differently, he cautions that in any investment, you must ensure that the valuations are reasonable so that if things don’t go quite as expected, you don’t get a very nasty shock.

Well, even on this score, South Indian Bank is comfortably placed. Banks are usually evaluated on a Price-to-book valuation. At CMP of about Rs. 186, South Indian Bank is presently quoting at a price-to-book valuation of 1.44. This is a bit high compared to its peers like as Karur Vysya Bank and Federal Bank which are trading at a price-to-book value of about 1.1. However, the slight premium that one is paying for South Indian Bank is well justified given the growth that it has shown in the immediate past and what is expected in the near future. South Indian Bank‘s EPS in FY 2010 was Rs. 20.44 and the PE at the CMP of Rs. 186 is a not-extravagant 9.09. Further, South Indian Bank declared a dividend of 40% which translates to a not-unreasonable dividend yield of 2.14%.

So, one would have to agree that Ramdeo Agarwal has indeed got himself a good stock in South Indian Bank.