India Banks Seeking Relative Value  Axis a good relative play — ::Citi Research

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India Banks
Seeking Relative Value
 Axis a good relative play — We believe relative value is the best way to invest in the
sector near-term: a) We prefer private- over public-sector banks (better loan mix,
profitability, relatively lower leverage, NPL coverage and credit costs); b) Axis Bank is
our preferred private-sector bank (discount to HDBK at 45%, 1.6 SD below mean); and
c) SBI among public-sector banks (improving NIM, relative value to BOB below mean).
 Macro uncertainty still high, could weigh on earnings — Stocks are factoring in
some uncertainties, but risks to earnings are still to the downside (sector P/E below
mean and P/B at mean). Stubborn, high interest rates could lower growth and NIM
estimates, and keep credit costs elevated. We expect the current asset-quality cycle to
be elongated (but less sharp) and should limit sharp stock downside – but also nearterm
upside. Key upside risks: lower inflation, faster macro/asset quality turnaround.
 Valuations marginally below mean, troughs well lower — Indian bank stocks have
corrected sharply from their peaks (-19% YTD). P/Bs (1.6x), though, are still only
marginally below historical averages. Past troughs are much farther away: -20% to -1
SD and -50% to trough. We believe downside risks outweigh upside potential in the
near term, though we do not expect valuations to relapse to past troughs.
 Comparing current fundamentals vs. 2008 crisis — Fundamentally, banks now
appear better placed to absorb the impact of any asset quality deterioration than they
were historically: a) Loan growth has been more moderate, in line with the overall
economic growth, suggesting excesses have been less; b) Profitability (ROA) has been
higher, especially NIMs, providing higher earnings cushion; and c) NPLs have been
more stable and coverage levels higher (especially for private banks).
 ROE not a strong indicator of valuations — Historically: a) Correlation between
profitability (ROA/ROE) and P/BV has been weak; b) Valuations for both private/public
sector banks appear indifferent to returns; c) Asset quality and growth outlook are
better indicators; high rates and growth slowdown suggest continued pain near-term.