[T.S.R:17558] Citi-Government Banks Yet To See A Business Upturn

Valuations have corrected to historical averages

— PSU bank valuations have corrected: PBV multiples (1.3x 1yr Fwd) and discount to private banks (~50%) are now in line with 5yr mean. Though more attractive, current multiples are well above trough (0.6x PBV Mar 09, previous macro down-cycle). Structural business improvements should limit downsides (higher floor for valuations) but upsides are linked to uptrends in macro (currently an overhang). Meanwhile we retain our bias for private banks (Axis top pick). Within PSU banks, we remain selective - preferred picks: SBI (strong deposit franchise, likely NIM improvement) and OBC (low valuations); avoid mid-cap PSU banks (Union). 

 

Waiting for signs of a macro turn to get more positive

— We are closer to getting more positive on PSU banks, but would still wait for initial signs of: a) Macro upturn (big upsides correlate with low inflation, easy liquidity, high loan growth); b) Moderation in cyclical pain (loan growth, margins likely lower in 1Q12); and c) Reduction in NPL formation (top-down overhang, partly priced in, but could worsen if macro deteriorates). 

 

Structural improvements in last 5yrs should raise valuation floor

— PSU banks have come a long way since 2006, having: a) Increased market shares (up 7ppt for covered banks), b) Improved loan pricing/mix (higher loan spreads), c) Reduced cyclical dependence on bonds (higher LDRs); and d) Gained operating efficiencies (cost/assets down 50bps, leveraging technology). Some gains are structural, fundamentally stabilizing return profiles (lower bond gains). Loss of funding franchise (CASA ratios down for all, avg -7ppt), is the key negative in our view - increasing sensitivity to liquidity, NIM volatility. Overall, we believe the structural improvements provide PSU banks a higher valuation floor, but up/down swings in growth, profitability, valuations will remain leveraged to the cyclical. 

 

Looking ahead: key trends for next 5yrs

— We expect Indian banks to see: a) Healthy loan growth (50% loan/GDP now); and b) Reasonable pricing/profitability. But, there will be challenges: a) More competition – likely new bank licenses; b) Higher core capital requirements – moderates leverage, ROEs, especially for PSU banks; and c) Challenging funding mix – low CASA, high LDRs set to accentuate cyclical gains/pains.
 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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