PSBs' re-rating to continue

Despite recent run-up and mixed Q4 performance, public sector banks' stocks could gain further as economic growth and private capex pick up

Stocks of public sector banks (PSBs) have made new 52-week highs this month, moving up from their improved show in the March quarter and also pricing in a potential pick-up in economic growth after the election of a strong government at the Centre.  Though a few have also disappointed, most analysts believe there are more legs to this rally. For, most of these scrips are still trading closer to their historical average one-year price/book ratio; also, foreign holding in these banks has not moved much from the lows of March 2009.

“Given a pro-growth and stable government, we are convinced  PSBs provide a compelling investment opportunity. This hope is backed by tangible prospects of a cyclical improvement in macros. Also, FII (foreign institutional investor) ownership in select PSBs (scrips) continues to remain at historic lows, providing further upside,” says Darpin Shah, banking analyst at HDFC Securities.

Reasonably valued, under-owned by FIIs
While State Bank of India (SBI) trades at 1.6 times the FY15 estimated book value (higher than its one-year average forward of 1.4 times), Bank of Baroda (BoB) at 1.2 times trades below the historical average of 1.3. After the positive surprise on asset quality in the March quarter results, most analysts have raised their target price on SBI. CLSA, Credit Suisse, Bank of America Merrill Lynch, Goldman Sachs and Citigroup have raised their target price on SBI, valuing it between Rs 2,400 and Rs 3,200. Macquarie, though, holds a contra view and believes SBI’s asset quality is not out of the woods yet. It has a target price of Rs 1,800 versus Monday’s closing price of Rs 2,700.

Punjab National Bank (PNB; one-fold the FY15 estimated book value) and the remaining four banks also trade at low valuations, the latter at 0.7-0.8 times the FY15 estimated book. The risk-reward equation for stocks of PNB and IDBI Bank, however, is not as favourable. For instance, IDBI has been falling short on Street expectations, given muted loan growth (single digits in the past few quarters).

Economic boost
Experts now believe immediate reforms are likely in stalled projects and in the power sector. PSBs stand to gain the most from these reforms due to their high exposure to infrastructure and power sectors. Improved cash flows in the hands of corporate India, along with kick-starting of projects, could lead to better asset quality and credit growth for these banks, believe analysts.

March quarter performance
For the March quarter, SBI, BoB and Canara Bank outperformed the Street’s expectations; PNB, BoI and IDBI disappointed. Union Bank posted in-line results. While IDBI and Union Bank reported subdued year-on-year loan growth of 0.7 per cent and 10.1 per cent, respectively, that of other banks was robust at 13-28 per cent. Agriculture and retail segments were key drivers of domestic loan growth. Net interest margins of PSBs remained largely stable due to lower cost of funds.

Barring BoB, all other banks witnessed a fall in net profit (see table) in the quarter, due to higher provision for bad loans. However, the profit beat was driven by stringent cost savings, strong fee-income growth and better asset quality for SBI, BoB and Canara Bank. PNB, BoI, Union Bank and IDBI, however, disappointed on asset quality.

 Among these top banks, PNB’s gross NPA ratio is the highest at 5.3 per cent of its advances. BoB has been maintaining its asset quality even in the toughest times and is among the top PSBs on this front. SBI, too, is addressing this issue as a top priority and is now reaping the benefits. Sale of bad debts to asset reconstruction companies (ARC) also benefited most banks.

Net slippage ratio (representing the addition of NPAs in a given period) improved sequentially for SBI (down 150 bps to 2.5 per cent), BoB (down 50 bps to 1.3 per cent), Canara Bank (down 30 bps to 3.5 per cent) and Union Bank (down 20 bps to 2.3 per cent).  This metric worsened by a huge 240-250 bps for the remaining banks, to 3.1 per cent for PNB, 4.2 per cent for IDBI and to 4.9 per cent for BoI in the March  quarter.  

Going forward, though, the managements of SBI, PNB and BoB have indicated that asset quality seems to have bottomed out and could improve. Asset quality woes, however, are likely to continue in the near term for BoI, Canara, Union Bank and IDBI Bank, given their sizable restructuring pipelines.