Rising RAM And Gold Loan Exposure Will Increase Credit Risks And Pressure Margins

Catalysts

About Canara Bank

Canara Bank is a large public sector bank in India focused on retail, agriculture, MSME and corporate lending, supported by an extensive digital and physical network.

What are the underlying business or industry changes driving this perspective?

• Rapid expansion in RAM and gold loan portfolios, while currently low in slippages, increases vulnerability to any downturn in household cash flows or collateral values. This could reverse the current trend of declining credit costs and pressure net margins.
• The structurally low CASA ratio relative to peers, despite recent initiatives and strong balance sheet growth, implies sustained dependence on higher cost term deposits. This limits the scope for durable NIM improvement and can constrain earnings growth when loan yields compress.
• Heavy reliance on gold loans and agricultural lending as key growth engines concentrates risk in segments sensitive to regulatory changes, rural stress and commodity cycles. This could interrupt loan growth and weaken revenue momentum if asset quality normalizes from current benign levels.
• Ambitious growth in MSME and corporate sanctions, including large undisbursed pipelines and M&A financing plans, exposes the bank to future cycles of stress in these historically volatile segments. This may potentially drive higher credit costs and erode the currently elevated provision coverage.
• Ongoing digital investments and capability building, while necessary to stay competitive, risk overshooting revenue benefits if competitive intensity in retail and fee products rises further. This may compress fee income and limit operating leverage gains needed to support earnings.

Assumptions

This narrative explores a more pessimistic perspective on Canara Bank compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Canara Bank's revenue will grow by 7.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 32.3% today to 23.6% in 3 years time.
• The bearish analysts expect earnings to reach ₹173.3 billion (and earnings per share of ₹19.1) by about December 2028, down from ₹191.6 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹263.2 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 8.9x on those 2028 earnings, up from 6.8x today. This future PE is lower than the current PE for the IN Banks industry at 11.4x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.76%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained double digit growth in global business alongside improving return on assets and nearly 19% year on year net profit growth suggests the franchise is capturing structural credit demand in India. This could support higher earnings and offset margin pressures, thereby challenging expectations of a weaker share price by stabilising or growing net profits.
• Continued reduction in gross and net NPA ratios, a slippage ratio below 1% and a provision coverage ratio above 93% indicate structurally stronger asset quality. This may keep credit costs low over the cycle and underpin resilient earnings rather than the deterioration implied by a bearish view.
• Management is building conservative buffers through additional standard asset provisioning, early adoption of expected credit loss style practices and steady recoveries from a large written off pool. These trends can smooth the impact of future credit cycles and support both net margins and bottom line earnings.
• Strategic focus on RAM segments, expansion in profitable gold loans, housing and vehicle finance, and targeted CASA initiatives supported by heavy and ongoing digital investments may deepen the retail franchise over time. This could gradually lift low cost funding and improve net interest margins and revenue growth.
• One off gains from recent stake sales in subsidiaries, recurring income from PSL certificates and the planned strengthening of capital markets and securities businesses could create additional, higher quality fee and treasury income streams. This would diversify away from pure spread income and support overall revenue and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Canara Bank is ₹112.08, which represents up to two standard deviations below the consensus price target of ₹147.92. This valuation is based on what can be assumed as the expectations of Canara Bank's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹171.0, and the most bearish reporting a price target of just ₹110.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ₹734.7 billion, earnings will come to ₹173.3 billion, and it would be trading on a PE ratio of 8.9x, assuming you use a discount rate of 14.8%.
  
• Given the current share price of ₹142.84, the analyst price target of ₹112.08 is 27.4% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.