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Indian financials - Play selective
Indian banking index (Bankex) has corrected +20% from its peak in Nov-
10 on concerns of inflation, rates and tight liquidity conditions. Even as
liquidity improves and inflation eases, Bankex may still underperform due
to headwinds on NIMs, asset quality and pension liabilities. Private banks
and quality wholesale funded names may however out-perform as they
are less impacted from these headwinds and are trading at small
premium/ discount to their relative history. PSU banks may see earnings
downgrade and premium contraction (most of them still trading at +1.5x
book) leading to further underperformance. We maintain our preference
for ICICI Bank, HDFC Bank, HDFC, IDFC and Yes Bank.
Past cycle suggests correction in Bankex may last for 1-2 quarters
Negative newsflows (bribery scandal, corruption and delay in capex cycle),
high inflation and extremely tight liquidity conditions (leading to an inverted
yield curve) have led to a sharp correction in banking stocks. Bankex is down
21% from its peak, underperforming the benchmark index by 9%. Even as we
are seeing some easing in liquidity and a likely moderation in inflation, we
believe the underperformance of banking stocks, especially PSU banks may
continue. As highlighted in our note ‘Is this cycle different’ in Aug-10, banking
stocks tend to correct sharply in phase 2 of the interest rate cycle (this phase
is when deposit rates rise more sharply than lending rates) and the correction
may last for 6-9 months.
Margin pressures, asset quality headwinds may lead to earnings cut
While concerns on liquidity and inflation will moderate, we believe most banks
will still see earnings downgrade cycle due to a) margin contraction, b) asset
quality pressures being worse than expected and c) pension liabilities being
significantly higher than initial estimates. The past cycle (where deposit rate
increase was much more spread out) led to a margin contraction of 30-60bps
and we believe the contraction for most state owned banks in this cycle would
be similar. For private banks and select PSU banks, margin pressures could be
muted, due to high CASA ratio and balanced ALM. Our interaction with PSU
bank management suggest that delinquencies / fresh restructuring is likely to
be higher in 3Q and this may lead to further earnings downgrades. Finally,
PSU banks could revise their pension liability estimates upwards by 30-40%
leading to a ~10% impact on FY12 earning estimates.
PSUs still expensive relative to history, private banks to out perform
Even after the sharp correction (20-37%) in PSU stocks, most are trading at a
significant premium to their five year average multiples with a relatively
weaker outlook. Also most PSUs are close to their peak leverage and will raise
fresh equity in next 12 months, leading to RoE compression. On the other
hand most private banks are trading at par or discount to their average
multiples and will see their premium expanding as they deliver a) stronger
earnings growth and b) RoE expansion.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian financials - Play selective
Indian banking index (Bankex) has corrected +20% from its peak in Nov-
10 on concerns of inflation, rates and tight liquidity conditions. Even as
liquidity improves and inflation eases, Bankex may still underperform due
to headwinds on NIMs, asset quality and pension liabilities. Private banks
and quality wholesale funded names may however out-perform as they
are less impacted from these headwinds and are trading at small
premium/ discount to their relative history. PSU banks may see earnings
downgrade and premium contraction (most of them still trading at +1.5x
book) leading to further underperformance. We maintain our preference
for ICICI Bank, HDFC Bank, HDFC, IDFC and Yes Bank.
Past cycle suggests correction in Bankex may last for 1-2 quarters
Negative newsflows (bribery scandal, corruption and delay in capex cycle),
high inflation and extremely tight liquidity conditions (leading to an inverted
yield curve) have led to a sharp correction in banking stocks. Bankex is down
21% from its peak, underperforming the benchmark index by 9%. Even as we
are seeing some easing in liquidity and a likely moderation in inflation, we
believe the underperformance of banking stocks, especially PSU banks may
continue. As highlighted in our note ‘Is this cycle different’ in Aug-10, banking
stocks tend to correct sharply in phase 2 of the interest rate cycle (this phase
is when deposit rates rise more sharply than lending rates) and the correction
may last for 6-9 months.
Margin pressures, asset quality headwinds may lead to earnings cut
While concerns on liquidity and inflation will moderate, we believe most banks
will still see earnings downgrade cycle due to a) margin contraction, b) asset
quality pressures being worse than expected and c) pension liabilities being
significantly higher than initial estimates. The past cycle (where deposit rate
increase was much more spread out) led to a margin contraction of 30-60bps
and we believe the contraction for most state owned banks in this cycle would
be similar. For private banks and select PSU banks, margin pressures could be
muted, due to high CASA ratio and balanced ALM. Our interaction with PSU
bank management suggest that delinquencies / fresh restructuring is likely to
be higher in 3Q and this may lead to further earnings downgrades. Finally,
PSU banks could revise their pension liability estimates upwards by 30-40%
leading to a ~10% impact on FY12 earning estimates.
PSUs still expensive relative to history, private banks to out perform
Even after the sharp correction (20-37%) in PSU stocks, most are trading at a
significant premium to their five year average multiples with a relatively
weaker outlook. Also most PSUs are close to their peak leverage and will raise
fresh equity in next 12 months, leading to RoE compression. On the other
hand most private banks are trading at par or discount to their average
multiples and will see their premium expanding as they deliver a) stronger
earnings growth and b) RoE expansion.
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