While valuations for the sector are demanding now, in the context of overall slow credit offtake, companies with better growth profile will continue to command premium valuations.
We believe the current recovery cycle will be less credit-intensive and we expect system growth to remain at 9-10% CAGR over FY17-19F, with corporate loans growing at just 6-7% CAGR and retail book (ex mortgages) growing at +15% CAGR. While valuations for the sector are demanding now, in the context of overall slow credit offtake, companies with better growth profile will continue to command premium valuations. Maintain our BUY rating on retail banks in spite of expensive valuations, as they are well placed on growth. HDFCB/Yes are our preferred names. Corporate asset quality will continue to stabilise but core PPOP pressure remains high and valuations are not undemanding after the catch-up in FY17. We prefer ICICI and SBI among the corporate banks.
Within NBFCs/HFCs, we have a mixed view on HFCs as real estate volumes remain weak and incremental mortgage spreads are under pressure. If the government schemes cannot offset a cyclical slowdown in real estate volumes, we see downside to our estimate. We downgrade LICHF to Neutral; maintain Neutral rating on HDFC Limited.
Operating profit will be key
FY17 was a year of stability in asset quality; hence we did see strong mean reversion in valuation for corporate banks. While we expect asset quality to stabilise further, part of that is in the price now and hence we believe PPOP performance will remain key.
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For retail banks, we expect 20-25% PPOP growth and that will help sustain higher multiples. For corporate banks, we expect PPOP performance especially in FY18F to remain challenging with low loan/fee growth (10-15% CAGR growth FY17-19F), which would cap multiple upsides. With less than 15% growth and falling incremental mortgage spreads, there is a possible risk to HFCs’ profit growth. The recent government subsidy scheme is positive, but we are not sure if it can offset the cyclical slowdown and margin pressure. Neutral LICHF and HDFC Ltd. A pick-up in collections for rural financiers makes them tactical BUYs (SHTF).