PSB stocks may play catch-up if asset quality stays stable

January 22, 2021 1:30 AM

Ever since the markets started making new highs since November, the Nifty Bank has rallied 34.7%. Conversely, the Nifty PSU Bank index has rallied 52% for the same period. The rally in PSU banking stocks has been driven by SBI, Bank of Baroda and Canara Bank, among others.

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By Urvashi Valecha

With initial concerns over the deteriorating asset quality subsiding, bank stocks have been on a roll. The Nifty Bank has rallied 92.4% from its March lows because of a sharp rise in the stocks of the private banks. In a stark contrast, public sector peers have risen 49.96% from their March lows. Stocks of public sector banks (PSBs) may play catch-up if these entities manage to rein in slippages.

Experts believe that the earnings growth of PSBs could also start delivering after a year which could lead to some kind of re-rating for these stocks. Foreign investment bank Macquarie has raised its earnings for PSU banks by 80% and 150% for FY22 and FY23, respectively, since the return on assets is very weak and a small change in credit cost assumptions results in massive earnings increase, driven by lower credit cost assumptions. For the overall banking sector, it has raised the target price by close to 30%.

Ever since the markets started making new highs since November, the Nifty Bank has rallied 34.7%. Conversely, the Nifty PSU Bank index has rallied 52% for the same period. The rally in PSU banking stocks has been driven by SBI, Bank of Baroda and Canara Bank, among others.

This, according to experts, has been driven by relatively cheap valuations and comparative stability in the asset quality on account of high provisioning, improvement in the economy and lower-than-expected credit costs. Deepak Jasani, head – retail research, HDFC Securities, said: “The valuation gap between the private banks and PSU banks is expected to narrow going forward on account of high provisioning at PSU banks and stable asset quality.”

The Nifty PSU Bank index currently trades at a one year forward price to book value of 0.52 times which is lower than its 10-year average of 0.87 times. On the other hand, the one year forward price to book value of Nifty Bank is 1.99 times.

Experts believe that leading PSB stocks such as SBI and BoB could deliver return on equity of more than 10% in fiscal year 2023. SBI, which has risen 7.3% in January, is among the preferred banking picks for brokerages such as Macquarie, Motilal Oswal, and Kotak Securities.

SBI has a provision coverage ratio (PCR) of close to 88% on corporate non-performing assets (NPAs), according to its Q2 numbers, higher than 65% PCR that was last seen in Q1 of fiscal year 2018. A high PCR means that the bank could see its credit costs going down by FY22, according to Motilal Oswal Institutional Equities. The brokerage said, “State Bank of India appears to be well positioned to report a strong uptick in earnings as the uncertainty brought about by the pandemic has receded significantly. Overall, we estimate FY 23 RoA and RoE of 0.8% and 14.5%.”

Similarly, brokerages such as Kotak Securities and Emkay Global have maintained a positive stance on the BoB stock which has risen 24.2% in January till date. Emkay Global said the overall management commentary seems positive, while valuations seem reasonable. It retains a ‘buy’ rating on BoB.

Market experts believe that the valuation gap between stocks of private banks and PSBs is likely to remain going forward even though it may narrow down. Rusmik Oza, executive vice president, head of fundamental research, Kotak Securities, said: “The wise gap in the valuation of both the segments would still remain because of multiple factors like capital adequacy ratio, RoE, margins, quality of book, among others.”

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