Goldman Sachs upgrades SBI to 'Buy', ups target price by 54%; here's why

Seen as the "proxy of improving confidence in the financial sector", Goldman Sachs believes SBI's current stock valuation (0.2x FY21E BVPS) makes for an attractive entry point

The stock price of State Bank of India (SBI) has been gradually marching upwards since its recent low of Rs 150.85 apiece touched on May 22, 2020. Till Tuesday, the stock price has advanced 38 per cent on the BSE, as against 26.6 per cent gain in the benchmark S&P BSE Sensex, BSE data show. With Goldman Sachs upgrading the stock to 'Buy' from 'Neutral' stance adopted in March, the bank is poised for stellar gains going-forward.

Seen as the "proxy of improving confidence in the financial sector", Rahul Jain, head of India Research at Goldman Sachs, in a co-authored report dated August 24 with Shagun Verma and Aakriti Kakkar, noted that SBI's current stock valuation (0.2x FY21E BVPS) makes for an "attractive entry point" as tail-risks related to YES Bank are likely under control, balance sheet and pre-provision operating profit (PPoP) management seems balanced, and valuations are at a steep discount to ICICI Bank/Axis Bank despite much better balance sheet management.

"In our bull case scenario, if the growth trajectory improves and asset quality turns out better than our expectations, the stock could further re-rate to 0.7x FY21E BVPS, implying 70 per cent upside to current prices," they said. At present, their 12-month target price is Rs 282 on the stock, which is 54 per cent higher than their previous target of Rs 183.

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"We raise our 12-month target price on the back of increase in medium term adjusted-ROEs (leverage X return on risk weighted assets) by 250 bps to 11.2 per cent; lower cost of equity, by 50 bps on lower risk-free rate; change in FY21 BVPS (c.+20%) as we no longer adjust the capital infusion into YES Bank from SBI’s net worth; and higher subsidiary valuations as we update valuations for the listed subs of SBI and value SBI Life Insurance based on market cap," the report said.

What's working for the stock?

According to Jain, YES Bank's ability to raise capital worth Rs 15,000 crore, amounting to nearly 70 per cent of its net worth, on its own has taken the private lender's Common Equity Tier-1 (CET-1) capital ratio to 13.4 per cent from 6.5 per cent at the end of Q1FY21. This has put YES Bank at par with other private banks, pointing towards moderating risk aversion in the industry.

"Post the capital raise, SBI’s stake in YES Bank has reduced to 30 per cent from 48 per cent... Further, the proportion of YES Bank’s net stress loans has nearly halved, from 64 per cent to 38 per cent post the equity infusion. We believe this takes away the tail risk of SBI needing to increase its involvement in YES bank or any other financial lender that might be undergoing stress," he said in the report.

Secondly, Jain believes that SBI has been able to navigate macro uncertainty and pandemic-induced slowdown better than expectation. This can be seen from slippages, which have moderated gradually, reducing below long term averages in the past couple of quarters and also screening consistently below peer banks like ICICI and Axis Bank. Goldman Sachs, however, is estimating fresh slippages at 4 per cent in FY21 (implying slippages of nearly 45 per cent on the moratorium book), as against management's forecast of 1.5 per cent, given the uneven macro recovery, intermittent lockdowns and surging virus cases.

Next, a comfortable provision coverage ratio (PCR) at 71 per cent as of Q1FY21, augurs well for the bank. Adjusted for loans under moratorium, the PCR stands at 45 per cent which is one of the highest among their coverage universe.

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The fourth factor that makes analysts at Goldman Sachs bullish on SBI is that the state-owned bank is sitting on significant unrealised gains on the investment book, which could account for around 18 per cent of loan loss provisions requirement over next 3 quarters. "As a result, with LLP/PPOP ratio at mid-70 levels in FY21-22E from nearly 100 per cent a few years back, we feel the bank’s profitability is relatively better cushioned from any deterioration in asset quality that should heighten the need for accelerated provisions. We expect SBI to deliver 0.5 per cent/0.9 per cent RoA/RoRWA over FY21-23E," they noted.

Goldman Sachs has revised its earnings estimates for the bank for FY21-23E by 35 per cent on average. "This is primarily driven by reduction in cost of risk by 40-55bps across FY21-FY23E and our marginally lower net interest income estimates from excess liquidity and delayed recovery in lending growth," the brokerage noted.

Key risks

Jain believes that any further challenges in YES Bank’s asset quality or liquidity positions, which could increase the probability of SBI stepping in to infuse funds, thereby delaying any recovery in its own operating performance as well as stability of growth,  would significantly hamper investor confidence.

That apart, instability in the financial system due to a failure of any NBFC or any other smaller private bank, higher-than-expected levels of restructured loans and NPL formation as well as uncertainty surrounding asset quality once moratorium ends on August 31, uncertainty surrounding loan restructuring, and challenges in maintaining operating profits due to sluggish loan growth, lower fee income and pressure on margins are other risks limiting upside.