Tale of three trades: India’s banks are possibly a tale of three trades: top down; asset quality; and loan growth. With the Bankex up 80% in 12 months (42% out-performance) and private banks up 100% (62% outperformance), we believe the top-down trade is done.
There’s still the asset quality and loan growth trades to play for: and we stay positive on banks on for these – but these will be slower coming (as will the rise of bank stocks).
Raise target prices (roll forward to Sep16, raise multiples: 0-20%), and upgrade HDFC Bank, Yes Bank to Buy. Banks are our largest OW (overweight) in our India Model Portfolio.
Top-down trade-up-front, and done: The top-down trade has likely played out; falling rates cycle (50 basis points more in FY16, with upside risk), falling inflation (oil a bonus), and the government (economic reforms, growth & regulations—bankruptcy, foreign ownership). You might get more, but the impact on bank stocks from here on should diminish rapidly. The top-down’s done.
Asset quality trade– sharpest, but pushed back: The asset quality (upswing) trade is getting pushed back: Q3 results (asset quality miss), management guidance (cautious) and economic data (slack IIP), all suggest the upswing is some time coming. Asset-quality swings usually impact stocks the sharpest (BS, P&L gains), but lag the top-down turns, and take time. For this cycle, it’s pushed back to H2FY16, and will likely take longer – but will matter materially.
Growth trade—low, and likely slow: The loan growth trade is slack; at barely 10% growth, limited visibility, credit caution, high dependence on retail, and some (foreign) disintermediation, it’s taking time (13-14%, FY16), and the uptick will be measured.
While a loan-growth uptick could precede the asset quality one, its stock impact is less than top-down or asset-quality trades. We see only a measured loan-growth pick-up, but the first signs should excite.
There’s more—but easy gains done: We remain positive on banks. But with fuller valuations & top-down gains done, the next leg of gains need a bottom-up & BS (balance sheet) response, and will come more slowly. Our top pick is now HDFC Bank, with SBI, ICICI BanK and Axis for asset quality leverage. And the pricier Yes and IIB (IndusInd Bank) as potential growth and margin uptick leaders. We raise target prices, primarily on roll forward to Sep ’16, measured multiple raises, and higher insurance business values.
Upgrade to Buy, raise target price to R1,325: We raise HDFC Bank to a Buy from a Neutral, with a new target price based on a 4.25x Sep16, PBV (price-to-book value) multiple. This multiple incorporates new capital raised by HDBK recently. HDFC Bank is now our top pick.
Best balance-sheet, for the credit up-cycle: HDBK’s is probably best positioned to ride India’s growth upcycle, as it plays out. It has raised capital (12%+ Tier-1), has no asset quality/ coverage issues, and a significant deposit /branch franchise to support growth. While it remains a credit conservative player, an upcycle will lend it disproportionate opportunities.
Balanced asset book: HDBK typically runs a balanced 50:50 retail: corporate loan book. It has also run a relatively short-duration, non-project finance book. This could offer a new market: as better quality and priced projects come to market, and peer banks, constrained by capital/ large exposures, stay away.
More reasonable valuations: While our target 4.25x multiple is still high, its premium to peers is more moderate than in the recent past. We do see an ROE (return on equity) range of about 20%.
Upgrade to Buy, raise target price to R1,025: We raise Yes Bank to a Buy (from Neutral), with a new target price based on a 3x PBV Sep 16 (previously 2.5x, March 16). This is at the mid-range of our multiples for private banks (2.4x – 4.25x), though we do raise it more aggressively (20%) than for its peers.
Progress in business consolidation, de-risking: Yes stepped off the growth pedal in 2013: but has in the process consolidated its business/mix on loans, deposits, branches and fees. There’s still some way to go before it matches its peers – or is ideally de-risked: but the franchise build (vis. BS or PL build) is underway, and we believe is getting increasingly institutionalised.
There’s capital leverage, and scale opportunities: With material capital in place, easing asset pressures and the benefits of a rising scale, a bigger market continues to open up for Yes, and it’s more competitive too. We see a a virtuous growth/ quality opening up for Yes – and this rises with an improving growth/ asset market.
Growth, margin and earnings leverage: An improving market, liquidity and BS mix gives it significant growth, margins and earnings leverage.
Risks: Yes does have its share of risks – small size, large wholesale funding (albeit well tested), some asset challenges, which have not gone away, and concentrated fee incomes. These would still leave Yes more vulnerable than peers in an economic reversal, or with any business slip-ups.