Country’s largest lender State Bank of India reported a ~75% y-o-y earnings increase, led by operating profits doubling year on year. Loan growth was solid at 20% y-o-y, net interest margin expanded ~30bps q-o-q, negligible slippages, gross non-performing loans (NPL) declined 40bps q-o-q and net NPLs fell 20bps q-o-q. Return on equity (RoE) touched ~18%. Valuations are still not expensive, despite this strong outperformance. We maintain a rating of BUY.
SBI reported ~75% y-o-y earnings growth, led by operating profits doubling y-o-y. Revenues grew 12% y-o-y with NII growth at 13% y-o-y, whereas non-interest income (NII) grew 8% y-o-y. NIM expanded 30bps q-o-q to 3.3%. Loans grew 20% y-o-y, which is at a decade high. Asset quality metrics showed further improvement, with the gross NPL ratio declining 40bps q-o-q to 3.5% and net NPL ratio declining 20bps q-o-q to 0.8%. Provision coverage ratio (PCR) stood at 78%. RoE stood at 18% and RoA at 1% of loans.
Our conversations with investors are shifting to peak earnings and return ratios from asset quality. There is strong comfort on SBI’s asset quality. The key question is what is the peak multiple for the bank and return ratios to justify that multiple. Peaks and troughs of cycles are hard to predict, and regulatory interventions such as those seen recently across the world make it even more challenging.
We look at the situation today as: (i) asset quality is comfortable, (ii) near-term credit cost is likely to be lower-than-long-term average, (iii) no asset bubbles, especially in real estate, currently, and (iv) capex-led loans, which tend to have a higher default than SME/retail loans, are not dominating loan growth.
Keeping a positive thesis is perhaps the best investment thesis on SBI, despite the sharp outperformance in recent years. The structure of the loan book suggests that the slowdown, if any, appears to be growth slowdown rather than a credit cost problem currently. There is a high probability that the lower credit costs can offset the pressure that could emerge from NIM compression, slower fee income growth or a marginally higher cost structure.
We maintain BUY with a FV of `725, at a valuation of 1.4X (adj.) book and 9X September 2024 EPS for RoEs of ~15%. There is a strong re-rating of the bank in recent quarters. Earnings upgrades, led by lower credit costs, have given comfort to this re-rating. However, we are getting closer to peak RoEs and re-rating is likely to get a lot slower.
Given the benign asset quality environment today, we expect SBI to continue showing healthy asset quality performance. Slippages are likely to stay contained, with strong recoveries and upgradations. The overall restructured book is relatively limited for the bank. Hence, we expect the credit cost to be below the historical average in the near term.
Of the bank’s loan book, ~41% is linked to marginal cost of funds based landing rate (MCLR), 34% is linked to external benchmark based lending rate (EBLR), 21% is fixed rate and the rest is linked to other external benchmarks. There is room for further improvement in yields, as the full impact of external benchmark-based pricing takes shape and the entire MCLR-linked portfolio gets repriced. As a result, we expect SBI’s margins to expand at least for another quarter, after which the increase in cost of funds will start offsetting the gain on yields front.