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India Financial Services: Structurally Attractive, but Cyclically Macro-Dependent
We remain structurally positive on Indian banks
given our expectation of robust profitability over the
medium term. In the past three months, these stocks
have been under pressure owing to domestic macro
headwinds and more recently owing to increasing oil
prices. If these headwinds continue, stock performance
could remain tepid. In this note, we take a closer look at
these headwinds and their implications.
Valuations have moved to average levels after the
recent correction: On our estimates, SOE banks are
trading at 8.5x F12e P/E and private banks at 16.2x.
These are broadly in line with the trailing five-year
averages and the only times these stocks have traded
lower have been during significant macro stress. The
question: how bad will macro stress get?
Macro trends – liquidity & food inflation – seem to
be improving at the margin… Inter-bank liquidity
deficit has improved from the bottom of US$32 bn to
US$11 bn recently. It could improve further, given the
increase in deposit rates. Food inflation pressures seem
to be cooling, down to 10% YoY from the peak of 21%.
…but oil prices could be a spanner in the works:
India is more vulnerable than regional peers to rising oil
prices – given twin deficits (current and fiscal deficit) and
an already high starting point for interest rates. We are
not making sustained higher oil prices a base case as of
now. However, if oil prices are sustained meaningfully
above US$100/bbl, it will have negative implications for
funding costs / margins and subsequently growth / asset
quality could come under pressure.
Adjusting estimates to reflect increased macro
uncertainty: Our macro team has taken down its GDP
growth estimate for F12 from 8.2% to 7.7%. Reflecting
this, we are adjusting our earnings/PTs to reflect lower
loan growth and weaker margins. Till further clarity
emerges on the macro outlook, we would favor more
defensive names (on a relative basis) like HDFC Bank
and SBI (given deposit franchises).
Investment Case
Indian financials are in a difficult spot. Structurally they remain
attractive and following the recent price corrections, valuations
are now entering attractive territory for longer-term investors.
Further, macro trends – inter-bank liquidity and domestic food
inflation – have also seen some improvement at the margin.
However, the recent rise in oil prices has again increased
concerns at the macro level. Indeed, indeed if oil prices remain
at these levels or increase further – Indian banks could remain
under pressure, in the near term. In this note, we assess the
downside risks.
Valuations for Indian banks are around historical
averages
Following the recent sharp correction, Indian banks’ valuations
have corrected to be close to historical average levels (at the
aggregate sector level). If we look at individual banks, there are
a few names where valuations have become very attractive
relative to their own history, even if we adjust earnings to iron
out any unsustainable earnings/profitability improvement
Macro trends seem to be improving at the margin
The key macro concerns that have put pressure on Indian
banks have been tight inter-bank liquidity conditions and
inflationary pressures (driven partially by food prices). Both
these concerns seem to be abating at the margin.
Interbank liquidity conditions seem to have improved: Net
repo balances have improved from the bottom of Rs1,439bn
(US$32bn) to Rs555bn (US$11bn) as of March 8, 2011. We
expect liquidity to remain under pressure in March owing to
seasonal factors. However, we expect to see improvement in
April-May 2011 as deposit growth continues to move up
following rate increases by the banks.
We summarize the macro environment prevailing in both these
normalization periods in Exhibit 13 on the following page.
There are two key factors that seem to drive the differential.
1) In the first period (when margin progression was relatively
better) – deposit growth picked up and loan growth
remained robust (though it did decelerate). In the second
period, the LD normalization was driven almost entirely by
loan growth deceleration – hence banks had to park the
deposits that they were collecting in low yielding
instruments (excess repo balances with the Central Bank,
liquid mutual funds) leading to sharp margin compression.
2) The second key factor that seemed to be at play is trend in
forex reserve accretion. The first period saw much
stronger accretion (which helps improve domestic liquidity)
and made the process of LD normalization more smooth
(and supported growth as well).
Based on this analysis, the margin outlook is contingent on the
economic / loan growth outlook and forex accretion.
In our base case earnings estimates, we are building in a
scenario similar to the first normalization period wherein loan
growth slows but remains robust, deposit growth picks up and
margins normalize from current peak levels but don’t collapse.
However, rising oil prices could weigh on the above trends
especially given that it has negative implications on both loan
growth (given higher inflation expectations) and forex reserve
accretion / domestic liquidity conditions.
To factor in the increased uncertainty, we are now building in a
slightly weaker margin progression for the SOE banks (which
have historically been more prone to see margins undershoot)
and the small private sector banks (with relatively weaker
liability franchises). Our NIM assumptions are summarized in
Exhibit 14 and the sensitivity to earnings from variance in these
assumptions are summarized in Exhibit 15.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Financial Services: Structurally Attractive, but Cyclically Macro-Dependent
We remain structurally positive on Indian banks
given our expectation of robust profitability over the
medium term. In the past three months, these stocks
have been under pressure owing to domestic macro
headwinds and more recently owing to increasing oil
prices. If these headwinds continue, stock performance
could remain tepid. In this note, we take a closer look at
these headwinds and their implications.
Valuations have moved to average levels after the
recent correction: On our estimates, SOE banks are
trading at 8.5x F12e P/E and private banks at 16.2x.
These are broadly in line with the trailing five-year
averages and the only times these stocks have traded
lower have been during significant macro stress. The
question: how bad will macro stress get?
Macro trends – liquidity & food inflation – seem to
be improving at the margin… Inter-bank liquidity
deficit has improved from the bottom of US$32 bn to
US$11 bn recently. It could improve further, given the
increase in deposit rates. Food inflation pressures seem
to be cooling, down to 10% YoY from the peak of 21%.
…but oil prices could be a spanner in the works:
India is more vulnerable than regional peers to rising oil
prices – given twin deficits (current and fiscal deficit) and
an already high starting point for interest rates. We are
not making sustained higher oil prices a base case as of
now. However, if oil prices are sustained meaningfully
above US$100/bbl, it will have negative implications for
funding costs / margins and subsequently growth / asset
quality could come under pressure.
Adjusting estimates to reflect increased macro
uncertainty: Our macro team has taken down its GDP
growth estimate for F12 from 8.2% to 7.7%. Reflecting
this, we are adjusting our earnings/PTs to reflect lower
loan growth and weaker margins. Till further clarity
emerges on the macro outlook, we would favor more
defensive names (on a relative basis) like HDFC Bank
and SBI (given deposit franchises).
Investment Case
Indian financials are in a difficult spot. Structurally they remain
attractive and following the recent price corrections, valuations
are now entering attractive territory for longer-term investors.
Further, macro trends – inter-bank liquidity and domestic food
inflation – have also seen some improvement at the margin.
However, the recent rise in oil prices has again increased
concerns at the macro level. Indeed, indeed if oil prices remain
at these levels or increase further – Indian banks could remain
under pressure, in the near term. In this note, we assess the
downside risks.
Valuations for Indian banks are around historical
averages
Following the recent sharp correction, Indian banks’ valuations
have corrected to be close to historical average levels (at the
aggregate sector level). If we look at individual banks, there are
a few names where valuations have become very attractive
relative to their own history, even if we adjust earnings to iron
out any unsustainable earnings/profitability improvement
Macro trends seem to be improving at the margin
The key macro concerns that have put pressure on Indian
banks have been tight inter-bank liquidity conditions and
inflationary pressures (driven partially by food prices). Both
these concerns seem to be abating at the margin.
Interbank liquidity conditions seem to have improved: Net
repo balances have improved from the bottom of Rs1,439bn
(US$32bn) to Rs555bn (US$11bn) as of March 8, 2011. We
expect liquidity to remain under pressure in March owing to
seasonal factors. However, we expect to see improvement in
April-May 2011 as deposit growth continues to move up
following rate increases by the banks.
We summarize the macro environment prevailing in both these
normalization periods in Exhibit 13 on the following page.
There are two key factors that seem to drive the differential.
1) In the first period (when margin progression was relatively
better) – deposit growth picked up and loan growth
remained robust (though it did decelerate). In the second
period, the LD normalization was driven almost entirely by
loan growth deceleration – hence banks had to park the
deposits that they were collecting in low yielding
instruments (excess repo balances with the Central Bank,
liquid mutual funds) leading to sharp margin compression.
2) The second key factor that seemed to be at play is trend in
forex reserve accretion. The first period saw much
stronger accretion (which helps improve domestic liquidity)
and made the process of LD normalization more smooth
(and supported growth as well).
Based on this analysis, the margin outlook is contingent on the
economic / loan growth outlook and forex accretion.
In our base case earnings estimates, we are building in a
scenario similar to the first normalization period wherein loan
growth slows but remains robust, deposit growth picks up and
margins normalize from current peak levels but don’t collapse.
However, rising oil prices could weigh on the above trends
especially given that it has negative implications on both loan
growth (given higher inflation expectations) and forex reserve
accretion / domestic liquidity conditions.
To factor in the increased uncertainty, we are now building in a
slightly weaker margin progression for the SOE banks (which
have historically been more prone to see margins undershoot)
and the small private sector banks (with relatively weaker
liability franchises). Our NIM assumptions are summarized in
Exhibit 14 and the sensitivity to earnings from variance in these
assumptions are summarized in Exhibit 15.
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