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Financials
Robust credit upcycle in FY12 can potentially throw up positive
surprises on growth, margins and asset quality
Near term we prefer private banks, especially smaller names with
higher growth and execution visibility. A significant stock price
correction could be entry opportunity for buying a sector basket
Top picks: Private – YES; PSU – Canara
2011 sector outlook
Firmly into the credit upcycle. 2011 is set to be
the second year of the current credit upcycle
where loan growth for the system is likely to
exceed 20% versus a more subdued 2010. Key
factors that will likely boost corporate credit
growth are pick-up in capex spending, a
consequent increase in working capital
requirements and reduced disintermediation due
to liquidity conditions. For most banks, margins
have peaked and are likely to stay flat in 1HCY11
as banks will likely offset higher funding costs
with improved pricing power. However, in
2HCY11 margins may be under pressure,
especially for public sector (PSU) banks, with the
current spate of deposit rate hikes taking effect.
Asset quality concerns for PSU banks may
continue for a couple of quarters, but
delinquencies are likely to reduce incrementally.
Thus, earnings drivers are likely to be dominated
by accelerating credit growth and lower credit
costs, whereas for private banks, it would be
credit growth and firm margins.
Potential surprises: Given the current
environment of tight liquidity, subdued credit
growth, deposit rate hikes and continuing
slippages, we may well be surprised by a
turnaround in sentiment post April-11, as liquidity
eases with the end of the busy season, a pickup in
government spending, increasing momentum in
credit growth and pricing power helping to
maintain margins, in addition to lower credit costs
helping a 20-25% earnings CAGR for PSU banks
up to FY13e and 25-35% for private banks.
Risk factors to watch out for: PSU banks’
earnings growth will likely be impacted
negatively by provisions for incremental pension
liabilities, the quantum of which remains
unascertained but could be as high as a year’s
worth of earnings.
Given the higher earnings visibility and fewer
concerns for private banks coupled with valuations
at their 5-year average levels vs. near all-time highs
for PSU banks, we continue to prefer private banks
to PSU banks in the near term.
2011 top pick
Yes Bank, OW, INR534
Key drivers – With its loan book market share of
just 0.8%, we estimate Yes’ key earnings drivers to
be higher than system loan growth, stable margins,
healthy fee income growth and low credit costs.
What is the street missing? – While the street is
expecting margin pressures due to a spike in
short-term rates and the wholesale nature of Yes’
balance sheet, we expect the pressure to be only
temporary. Almost 90% of its assets and liabilities
reprice in one year, which should help protect its
margins in an environment where pricing power is
likely to return to the sector in FY12.
Upcoming catalysts – Structural business shift
towards retail over the next few years. We expect
branches to grow from 150 to 450 by FY13e,
which will drive its retail business, currently nonexistent
on its balance sheet.
Brief investment thesis – Yes is well-placed
structurally and cyclically to deliver growth and
profitability. A quality management and a strong
execution track record will help the bank leverage
its ROE to 20%+ levels. The stock is trading at a
significant discount to private banks at 11.2x PE
and 2.3x PB on a 12-month rolling basis. We
reiterate our Overweight rating, valuing the stock
at 18x PE and 2.5x PB, giving a 12-month target
price of INR534, implying 87% potential return.
Sector valuations and risks
We value Indian banks using a weighted average
combination of PE, PB, and economic profit
model (EPM) methodologies. We assign a 75%,
15% and 10% weight each to the PE, PB and
EPM components, respectively. The three-stage
EPM uses explicit forecasts until FY13e (other
than HDFC, for which we have estimates till
FY12e), followed by 10 years of semi-explicit
forecasts. The final stage of 12 years (fade period)
assumes convergence of ROE and COE.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Financials
Robust credit upcycle in FY12 can potentially throw up positive
surprises on growth, margins and asset quality
Near term we prefer private banks, especially smaller names with
higher growth and execution visibility. A significant stock price
correction could be entry opportunity for buying a sector basket
Top picks: Private – YES; PSU – Canara
2011 sector outlook
Firmly into the credit upcycle. 2011 is set to be
the second year of the current credit upcycle
where loan growth for the system is likely to
exceed 20% versus a more subdued 2010. Key
factors that will likely boost corporate credit
growth are pick-up in capex spending, a
consequent increase in working capital
requirements and reduced disintermediation due
to liquidity conditions. For most banks, margins
have peaked and are likely to stay flat in 1HCY11
as banks will likely offset higher funding costs
with improved pricing power. However, in
2HCY11 margins may be under pressure,
especially for public sector (PSU) banks, with the
current spate of deposit rate hikes taking effect.
Asset quality concerns for PSU banks may
continue for a couple of quarters, but
delinquencies are likely to reduce incrementally.
Thus, earnings drivers are likely to be dominated
by accelerating credit growth and lower credit
costs, whereas for private banks, it would be
credit growth and firm margins.
Potential surprises: Given the current
environment of tight liquidity, subdued credit
growth, deposit rate hikes and continuing
slippages, we may well be surprised by a
turnaround in sentiment post April-11, as liquidity
eases with the end of the busy season, a pickup in
government spending, increasing momentum in
credit growth and pricing power helping to
maintain margins, in addition to lower credit costs
helping a 20-25% earnings CAGR for PSU banks
up to FY13e and 25-35% for private banks.
Risk factors to watch out for: PSU banks’
earnings growth will likely be impacted
negatively by provisions for incremental pension
liabilities, the quantum of which remains
unascertained but could be as high as a year’s
worth of earnings.
Given the higher earnings visibility and fewer
concerns for private banks coupled with valuations
at their 5-year average levels vs. near all-time highs
for PSU banks, we continue to prefer private banks
to PSU banks in the near term.
2011 top pick
Yes Bank, OW, INR534
Key drivers – With its loan book market share of
just 0.8%, we estimate Yes’ key earnings drivers to
be higher than system loan growth, stable margins,
healthy fee income growth and low credit costs.
What is the street missing? – While the street is
expecting margin pressures due to a spike in
short-term rates and the wholesale nature of Yes’
balance sheet, we expect the pressure to be only
temporary. Almost 90% of its assets and liabilities
reprice in one year, which should help protect its
margins in an environment where pricing power is
likely to return to the sector in FY12.
Upcoming catalysts – Structural business shift
towards retail over the next few years. We expect
branches to grow from 150 to 450 by FY13e,
which will drive its retail business, currently nonexistent
on its balance sheet.
Brief investment thesis – Yes is well-placed
structurally and cyclically to deliver growth and
profitability. A quality management and a strong
execution track record will help the bank leverage
its ROE to 20%+ levels. The stock is trading at a
significant discount to private banks at 11.2x PE
and 2.3x PB on a 12-month rolling basis. We
reiterate our Overweight rating, valuing the stock
at 18x PE and 2.5x PB, giving a 12-month target
price of INR534, implying 87% potential return.
Sector valuations and risks
We value Indian banks using a weighted average
combination of PE, PB, and economic profit
model (EPM) methodologies. We assign a 75%,
15% and 10% weight each to the PE, PB and
EPM components, respectively. The three-stage
EPM uses explicit forecasts until FY13e (other
than HDFC, for which we have estimates till
FY12e), followed by 10 years of semi-explicit
forecasts. The final stage of 12 years (fade period)
assumes convergence of ROE and COE.
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