Street bets on bank stocks despite asset quality concerns

Written by fe Bureau | Mumbai | Updated: Oct 25 2013, 22:15pm hrs
Bank stocksAnalysts remain cautious ahead of next week?s US Federal Open Market Committee meet. AP
Given the recent outperformance of banking stocks and their contribution to the broad rally in Indian equities, the Street continues to bet on the sector with a neutral-to-positive outlook in the near term on hopes of easing liquidity conditions.

While the Bank Nifty failed to close above its crucial psychological level of 11,000 on Thursday, analysts foresee more room for upside. Valuations are far lower than what the market saw when Sensex was at its peak in November 2010, say analysts, adding that improvement in liquidity and stability in the rupee could help financial stocks move higher.

However, analysts remain cautious ahead of next weeks US Federal Open Market Committee meet and Reserve Bank of India (RBI) policy, and are mostly betting on names with strong performance and minimal asset quality concerns.

On Thursday, Bank Nifty touched its three-month high of 11,091.60, but was unable to sustain the gains, and eventually ended the day at 10,902, up 21.80 points, or 0.2%. Since September, Bank Nifty has gained 25%.

While private banks are better placed than their public counterparts, public sector banks could actually become interesting bets depending on valuations and rate cycle. The Street expects RBI to hike rates by 25 bps. We believe the tone of RBI governors commentary towards growth, inflation and currency will give clear direction to banks stocks in the near-to-medium term, said Vinay Khattar, head research, Edelweiss Financial Services.

Khattar added that governments move to infuse capital into public sector banks is mildly positive. Capital infusion had to be done. It is the right thing, but the quantum No. In our view, valuations and rate cycle will play a more important role, Khattar said.

On Wednesday, the government approved infusion of a total of R14,000 crore into 20 public sector banks in the current fiscal by way of preferential allotment of equity shares.

According to Bloomberg data, all stocks in the Bank Nifty universe are trading at far lower valuations than the highs of November 2010. For instance, HDFC Bank is trading at a one-year trailing price-to-book value of 4.34 times. In November 2010, when Sensex peaked at 21,000 levels, HDFC Bank was valued at 5.65 times its one-year trailing book value. Similarly, the countrys largest lender, State Bank of India, is trading at one-year price-to-book value of 0.94 times against 2.66 times in November 2010.

The difference in valuations of banking shares stands at 0.7-2.5 times between now and November 2010, Bloomberg data show. However, a section of the industry believes that valuations could be deceiving and investors must pick up stocks based on balance sheet strength and asset quality.

Analysts said that since public sector banks are yet to announce their Q2 results, they remain cautious. The challenging business environment is seen pushing up NPLs and could impact stocks despite attractive valuations. Public sector banks Indian Bank, United Bank, Bank of India, Union Bank, IOB and Punjab & Sindh Bank are among the most beaten down BSE 500 stocks, with YTD declines of anywhere between 40% and 60% this year.

We remain underweight on public sector banks. Valuations are attractive but investors must look at valuations with respect to asset quality and overall performance of banks. In our view, balance sheet of some of the banks, especially public ones, continue to appear stretched, said Dhananjay

Sinha, head research, institutional equities, Emkay Global Financial Services.