A series of interest rate hikes, global economic weakness and worries on domestic growth have soured the pitch for financials. A difficult operating environment is bound to manifest in muted credit growth, lower NIMs and worsening asset quality - leading to a sharp de-rating of bank stocks (down 9% vis-à-vis Sensex in two months). To ascertain what stocks are pricing in, we have conducted a sensitivity analysis based on Gordon Growth Model assuming a stable cost of capital at current levels. Our analysis reveals that the market is building in steep profitability erosion (up to 70bp decline in RoA) due to a rise in gross NPAs (to 5-8%) and further margin decline of 25-30bp. However, we believe the margin contraction is largely behind (~15bp decline in FY12E). Also, we see banking system NPAs+restructured assets peaking at 7.8% in FY13 vis-à-vis 5.8% now (refer our asset quality report dated 2 August 2011). With bulk of the stress likely to be restructured, associated credit costs would be minimal. While global uncertainties remain an overhang, any whiff of easing interest rates would trigger a rebound in financials, led by large cap sector bell-weathers. However, we believe higher beta stocks with maximum skepticism on profitability and highest discount to long-term valuations will outperform over 12-18 months. Headwinds do exist but concerns seem overdone…: Given a sluggish domestic economy as also global uncertainties, we expect the RBI to pause after another 25bp hike in policy rates (if any). Peaking of the rate cycle and seasonal pick-up in credit would bode well for NIMs. For FY12, we see a ~15bp decline with a milder dent for private banks (~7bp) than PSU peers (~20bp). Also, we see banking system NPAs + restructured assets peaking at 7.8% in FY13 vs. 5.8% now. …and valuations discounting exaggerated negatives: Financials have corrected sharply on concerns of higher interest rates (lower credit growth and NIMs) and slower economic growth (asset quality deterioration). Using the Gordon Growth Model, we evaluate what stock prices are building in. Our analysis reveals that the market expects steep profitability erosion for banks, primarily led by a spike in credit costs. The market implicitly estimates a 2-3x rise in banks’ NPA ratios and 20-70bp rise in credit costs over the next two years. High-beta stocks should outperform as the cycle turns: With stocks trading at a discount to historical averages, the risk-reward is favorable. Though near term overhang of a global crisis remains, we see a sharp rebound in banking stocks in next 12 months as interest rates peak. We recommend shifting to higher beta stocks to play the upturn. Our preferred picks are Union Bank (23% discount in valuations and 45bp disbelief on RoA), Canara Bank (27% and 90bp), PNB (16% and 65bp), OBC (25% and 54bp), Axis Bank (23% and 34bp), Yes Bank (27% and 28bp) and ING Vysya Bank (14% and 37bp). Comparative valuations Companies Recommendation Price Mkt cap TP Earnings CAGR EPS* P/E* P/Adj BV* RoE* RoA* (Rs) (Rs bn) (Rs) FY11-13E (%) (Rs) (x) (x) (%) (%) Union Bank Outperformer 230 120 415 26.5 51.2 4.5 1.0 22.2 1.0 Canara Bank Outperformer 459 203 650 18.4 102.7 4.5 1.0 22.8 1.2 PNB Outperformer 973 308 1350 20.4 166.3 5.8 1.3 23.6 1.3 OBC Outperformer 301 88 470 22.0 59.9 5.0 0.8 14.8 1.0 Axis Bank Outperformer 1,103 453 1700 25.0 103.4 10.7 2.0 20.5 1.6 ING Vysya Bank Outperformer 313 46 480 33.0 35.5 8.8 1.2 13.4 1.0 Yes Bank Outperformer 283 98 440 33.0 28.3 10.0 2.1 23.3 1.4 Source: IDFC Securities Research, * For FY12E Indian Financials What are the stock prices saying? INSTITUTIONAL SECURITIES INDIA RESEARCH FINANCIALS SECTOR UPDATE BSE SENSEX: 17025 17 OCTOBER 2011 For Private Circulation only. Important disclosures appear at the back of this report” SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33. Pathik Gandotra [email protected]91-22-6622 2525 Chinmaya Garg [email protected]91-22-6622 2563 Kavitha Rajan [email protected]91-22-6622 2697
48
Embed
INDIA RESEARCH FINANCIALS SECTOR UPDATE BSE SENSEX: … · 5 | OCTOBER 2011 IDFC SECURITIES Exhibit 3: Implied RoE at current multiples P/ BV (x) ROE (%) FY12 FY13 FY11A FY12 FY13
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
A series of interest rate hikes, global economic weakness and worries on domestic growth have soured the pitch for financials. A difficult operating environment is bound to manifest in muted credit growth, lower NIMs and worsening asset quality - leading to a sharp de-rating of bank stocks (down 9% vis-à-vis Sensex in two months). To ascertain what stocks are pricing in, we have conducted a sensitivity analysis based on Gordon Growth Model assuming a stable cost of capital at current levels. Our analysis reveals that the market is building in steep profitability erosion (up to 70bp decline in RoA) due to a rise in gross NPAs (to 5-8%) and further margin decline of 25-30bp. However, we believe the margin contraction is largely behind (~15bp decline in FY12E). Also, we see banking system NPAs+restructured assets peaking at 7.8% in FY13 vis-à-vis 5.8% now (refer our asset quality report dated 2 August 2011). With bulk of the stress likely to be restructured, associated credit costs would be minimal. While global uncertainties remain an overhang, any whiff of easing interest rates would trigger a rebound in financials, led by large cap sector bell-weathers. However, we believe higher beta stocks with maximum skepticism on profitability and highest discount to long-term valuations will outperform over 12-18 months.
Headwinds do exist but concerns seem overdone…: Given a sluggish domestic economy as also global uncertainties, we expect the RBI to pause after another 25bp hike in policy rates (if any). Peaking of the rate cycle and seasonal pick-up in credit would bode well for NIMs. For FY12, we see a ~15bp decline with a milder dent for private banks (~7bp) than PSU peers (~20bp). Also, we see banking system NPAs + restructured assets peaking at 7.8% in FY13 vs. 5.8% now.
…and valuations discounting exaggerated negatives: Financials have corrected sharply on concerns of higher interest rates (lower credit growth and NIMs) and slower economic growth (asset quality deterioration). Using the Gordon Growth Model, we evaluate what stock prices are building in. Our analysis reveals that the market expects steep profitability erosion for banks, primarily led by a spike in credit costs. The market implicitly estimates a 2-3x rise in banks’ NPA ratios and 20-70bp rise in credit costs over the next two years.
High-beta stocks should outperform as the cycle turns: With stocks trading at a discount to historical averages, the risk-reward is favorable. Though near term overhang of a global crisis remains, we see a sharp rebound in banking stocks in next 12 months as interest rates peak. We recommend shifting to higher beta stocks to play the upturn. Our preferred picks are Union Bank (23% discount in valuations and 45bp disbelief on RoA), Canara Bank (27% and 90bp), PNB (16% and 65bp), OBC (25% and 54bp), Axis Bank (23% and 34bp), Yes Bank (27% and 28bp) and ING Vysya Bank (14% and 37bp).
HDFC Bank ................................................................................................................35
ICICI Bank ..................................................................................................................37
IndusInd Bank ............................................................................................................41
ING Vysya Bank .........................................................................................................43
Yes Bank ....................................................................................................................45
3 | OCTOBER 2011 IDFC SECURITIES
INVESTMENT ARGUMENT Financials have corrected sharply, to below their long-term averages, on concerns
of deteriorating asset quality and muted credit growth
Our analysis based on the Gordon growth model indicates that stocks are building in a 2-3x rise in banks’ NPAs and 20-70bp rise in credit costs over the next two years
We believe concerns are overdone; we estimate ‘gross NPAs plus restructured assets’ for the system to peak at 7.8% in FY13
Expect margins of our coverage universe to decline by ~15bp, with private banks being better placed than PSU peers (~7bp yoy vis-à-vis ~20bp decline for PSU banks)
We expect stocks factoring in higher ‘disbelief’ and ‘deep valuations’ to offer the highest returns as the cycle turns
Financials stocks: Pricing in overstressed concerns
Banking stocks have reacted strongly to the concerns building up around asset quality and sluggish credit off-take. With high lending rates, stand-still corporate capex, slowing infrastructure investments, subdued retail loan demand and a weak global economy, system credit growth is expected to moderate in FY12. Further, the cyclical slowdown is sure to strain the repayment capability of various quarters, thereby raising a red flag on asset quality of banks.
Exhibit 1: Banks have underperformed Sensex since November 2010
Source: Bloomberg
Reeling under this barrage of negative news, financial stocks have corrected sharply by 21% YTD and underperformed the Sensex by 11%. The underperformance has been starker for PSU banks (down 16% YTD). Financial stocks in our coverage universe are now trading at a discount of up to ~20% to their 5-year trading averages. Nevertheless, valuations are still much ahead of the trough levels of FY09.
High lending rates, muted corporate capex and dull
retail loan demand among spate of headwinds…
…beating down financial stocks by ~20% YTD, with
PSU banks being the worst-hit
4 | OCTOBER 11 IDFC SECURITIES
Exhibit 2: Bank valuations at a discount to long term averages
Source: Bloomberg
Assessing the implied profitability
While current valuations appear attractive, concerns around onset of a new NPA cycle and earnings deterioration have impelled investors to avoid increasing weights in Indian banks until the macro headwinds abate. While the prevalent concerns are justified, the magnitude of same is extremely exaggerated in our view. In this light, we attempt to put current valuations in perspective and assess what financial stocks are currently pricing in. We have conducted a sensitivity analysis using the Gordon Growth model and current trading multiples; our analysis reveals that banking stocks are factoring in a much lower RoE – implying a steep profitability erosion in the coming period. Our analysis assumes that interest rates have peaked and cost of capital would remain constant at current levels.
0.0
1.0
2.0
3.0
4.0
Sep-
05
Mar
-06
Sep-
06
Mar
-07
Sep-
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
ICICI Bank PB (x) Average
0.0
1.0
2.0
3.0
4.0
5.0
Sep-
05
Mar
-06
Sep-
06
Mar
-07
Sep-
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
Axis Bank PB (x) Average
0.0
0.5
1.0
1.5
2.0
Sep-
05
Sep-
06
Sep-
07
Sep-
08
Sep-
09
Sep-
10
Sep-
11
Union PB (x) Average
0.0
0.5
1.0
1.5
2.0
2.5
Sep-
05
Mar
-06
Sep-
06
Mar
-07
Sep-
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
SBI PB (x) Average
`
0.0
1.5
3.0
4.5
6.0
Sep-
05
Mar
-06
Sep-
06
Mar
-07
Sep-
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
Yes Bank PB (x) Average
Fears of the onset of a new NPA cycle beset
stocks, though valuations look attractive
0.40
0.80
1.20
1.60
2.00
Sep-
05
Mar
-06
Sep-
06
Mar
-07
Sep-
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
PNB PB (x) Average
5 | OCTOBER 2011 IDFC SECURITIES
Exhibit 3: Implied RoE at current multiples
P/ BV (x) ROE (%) FY12 FY13 FY11A FY12 FY13 PSU Banks Bank of Baroda 1.3 1.1 25.5 14.8 13.0 Bank of India 1.1 0.9 17.8 14.3 12.6 Punjab National Bank 1.3 1.0 24.5 14.9 12.8 State Bank of India 1.2 1.0 12.6 13.3 11.8 Union Bank of India 1.0 0.8 20.9 12.0 10.6 OBC 0.8 0.7 17.0 10.7 9.7 Allahabad Bank 0.8 0.7 21.0 11.3 10.0 Canara Bank 1.0 0.8 26.4 12.5 10.9 Corporation Bank 0.7 0.6 21.9 10.1 9.2 Indian Bank 0.9 0.7 22.3 12.1 10.5 Pvt Banks Axis Bank 2.0 1.7 19.3 22.3 19.7 HDFC Bank 3.7 3.2 16.7 31.3 27.5 ICICI Bank 1.3 1.2 9.7 18.3 17.4 Yes Bank 2.1 1.7 21.1 24.2 20.7 IndusInd Bank 2.7 2.3 19.3 26.8 23.3 ING Vysya Bank 1.2 1.1 13.4 14.3 13.2
On the basis of the above determined implied RoEs, we ascertain the profitability or RoAs reflected in the stock prices at leverage levels of FY11. Stock prices, we believe, are factoring in an up to 70bp decline in RoAs from FY11.
Exhibit 4: Implied RoA at current multiples
Assets/ Equity (x) Implied RoA (%) FY11A FY11A FY12E FY13E Change over FY11-13E PSU Banks Bank of Baroda 21 1.33 0.71 0.62 (0.71) Bank of India 21 0.79 0.69 0.60 (0.19) Punjab National Bank 19 1.31 0.77 0.67 (0.65) State Bank of India 14 0.73 0.96 0.85 0.12 Union Bank of India 21 0.97 0.58 0.51 (0.45) OBC 21 1.01 0.52 0.47 (0.54) Allahabad Bank 21 1.04 0.54 0.48 (0.56) Canara Bank 25 1.34 0.50 0.44 (0.90) Corporation Bank 19 1.11 0.53 0.48 (0.63) Indian Bank 21 1.54 0.58 0.50 (1.03) Pvt Banks Axis Bank 16 1.60 1.43 1.26 (0.34) HDFC Bank 18 1.57 1.75 1.54 (0.03) ICICI Bank 15 1.34 1.25 1.18 (0.16) Yes Bank 17 1.52 1.45 1.24 (0.28) IndusInd Bank 19 1.43 1.39 1.21 (0.21) ING Vysya Bank 18 0.87 0.80 0.74 (0.13)
Gordon Growth analysis points to a steep erosion
in profitability…
Gordon Growth analysis points to a steep erosion
in profitability…
6 | OCTOBER 11 IDFC SECURITIES
The market’s view of a gloomy outlook appears to be based on the following:
• A substantial decline in NIMs from levels witnessed in Q1FY12; and/ or
• RoA reduction is also assumed to be flowing from higher credit costs. The market implicitly builds in a 2-3x rise in banks’ NPA ratios and 20-70bp rise in credit costs over the next two years.
Bank of Baroda, Punjab National Bank and Union Bank among PSU banks, and Axis Bank and ICICI Bank among private ones are pricing in the steepest decline in profitability.
Exhibit 5: Summary of implied key metrics
Prov/ avg assets (%) Gross NPAs (%) NIM (%) FY11A FY12 FY13 FY11A FY12 FY13 FY11A FY12 FY13 PSU Banks Bank of Baroda 0.4 0.9 1.0 1.4 3.2 5.2 2.7 2.3 2.3 Bank of India 0.6 0.6 0.8 2.3 3.4 5.0 2.5 2.1 2.2 Punjab National Bank 0.7 1.3 1.5 1.7 4.2 7.0 3.5 3.2 3.2 State Bank of India 0.9 0.8 0.9 3.3 4.3 6.0 2.9 2.9 2.9 Union Bank of India 0.6 0.9 1.0 2.4 4.2 6.2 2.9 2.5 2.6 OBC 0.8 1.0 1.1 1.9 4.1 6.5 2.8 2.4 2.4 Allahabad Bank 0.8 1.3 1.4 1.8 4.1 6.6 2.9 2.8 2.7 Canara Bank 0.4 1.1 1.3 1.5 3.8 6.4 2.6 2.1 2.2 Corporation Bank 0.5 0.9 0.9 0.9 2.7 4.6 2.3 1.9 1.9 Indian Bank 0.6 1.5 1.7 1.0 4.3 8.0 3.6 3.1 3.2 PVT Banks Axis Bank 0.6 0.5 0.8 1.1 2.1 3.9 3.1 2.7 2.8 HDFC Bank 0.8 0.6 0.7 1.1 1.7 2.4 4.2 4.1 4.0 ICICI Bank 0.4 0.4 0.7 4.5 5.7 7.6 2.3 2.2 2.4 Yes Bank 0.2 0.1 0.4 0.2 0.2 0.9 2.6 2.4 2.4 IndusInd Bank 0.3 0.5 0.6 1.0 2.1 3.6 3.4 3.2 3.2 ING Vysya Bank 0.4 0.4 0.6 2.3 3.1 4.4 2.8 2.7 2.7
We see the glass as half-full
We concur that the two key headwinds for the sector are slower revenue growth (volumes and margins) and concerns on asset quality. However, we believe that the concerns are overstressed. On volumes, we have built in meaningful slowdown already. On margins, a large part of the contraction is likely behind. Banks with large wholesale funding are likely to witness some uptrend over the next couple of quarters, as lending rates have risen and wholesale funding costs have stabilized for the past three months. We also strive to gauge the extent of the asset quality damage and conclude that the stress would be manageable.
Expect a 15bp decline in NIMs in FY12
High systemic rates have driven a strong flow of deposits into the banking system. However, sluggish demand for credit, and thereby the sector’s declining loan-to-deposit ratio (43% YTD vs 83% in FY11), is bound to be a drag on NIMs. Nevertheless, deposits have been outpacing loan growth and we see wholesale deposit rates coming off over the next couple of quarters (already stable since past three months). Due to the higher funding costs, net interest margin for stocks under our coverage have declined by 20-30bp in the past two quarters. In H2FY12, margins should receive support from lower
Market pessimism triggered by substantial
dip in NIMs…
…and 2-3x rise in NPA ratios and 20-70bp rise in credit costs over the next
two years
Market concerns on slower revenue growth and asset quality are
overblown
Declining loan-to-deposit ratio to be a drag on NIMs
7 | OCTOBER 2011 IDFC SECURITIES
wholesale rates as also a seasonal pick-up in credit growth. Overall for FY12, we expect margins of our coverage universe to decline by ~15bp (vs the 25-30bp that is seemingly factored into CMPs). We see private banks better placed than PSU peers (~7bp yoy vis-à-vis ~20bp decline for PSU banks) owing to more aggressive rate hikes as also better ALM for the former.
Exhibit 6: Margin trends
2.952.88
3.07
2.81
2.69
3.01
2.86
2.71
3.10
2.2
2.5
2.7
3.0
3.2
(%)
All banks PSU Banks Private Banks
FY11 FY12E FY13E
Source: IDFC Securities Research and company reports
Asset quality stress appears to be manageable
Asset quality deterioration has been evident for PSU banks over the past two quarters. While higher slippages have been partially driven by transition to system recognition of NPAs, the sharp rise in interest rates and economic slowdown too has hit the underlying credit quality. Weak domestic as well as international demand, high commodity prices and dithering capital markets have impacted cash flows of borrowers, thereby raising the probability of loan defaults. While retail loans remain resilient on the back of rising wages, stress points are already visible on SME and agriculture portfolios. Agriculture portfolio is also facing stress due to ‘moral hazard’ – fallout of the government’s agriculture debt waiver scheme.
Exhibit 7: Banks’ gross NPAs have risen after moderation over FY05-08
3.0 2.8
1.8
1.4 1.3
1.4
1.9 1.9
0
150
300
450
600
750
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY100.0
0.7
1.4
2.1
2.8
3.5Slippage (Rs bn - LHS) Slippage (% - RHS)
Source: The RBI and IDFC Securities Research
10% CAGR FY03-08
38% CAGR FY08-10
Private Banks’ better placed than PSU peers to tackle stress on NIM due
to better ALM
Retail loans seem resilient, but SME and agriculture segments
remain vulnerable
8 | OCTOBER 11 IDFC SECURITIES
Exhibit 8: Continued stress in industry and agricultural portfolio over FY10-11
Source: The RBI and IDFC Securities Research
We assess ~17% of outstanding bank credit to be stressed
Applying credit screens (interest coverage and leverage ratios) indigenous to each segment of bank credit, we conclude ~17% of bank credit is under stress, of which a proportion is likely to manifest as NPAs or get restructured (see our report: ‘Asset Quality - That sinking feeling!’ dated August 2, 2011). Corporate portfolio emerges as the largest contributor to stress (~24% of sector) followed by agriculture (20%).
Exhibit 9: Identifying the pain points
Source: RBI, Capitaline, IDFC Securities Research
Exhibit 10: Significant proportion of stressed debt flows from corporate segment
Source: RBI, Capitaline, IDFC Securities Research
3.9
2.4
0.9 1.1
3.1
0.8
2.92.8
2.1
1.7 1.8
2.6
1.1
2.5
-
1.1
2.2
3.3
4.4
SBI ICICI Bank PNB BoB BoI CBK UNBK
2010
NPA % in Industry sector
2011
2.6
5.6
3.73.3
2.41.8
2.2
6.7
7.6
NPA % in agriculture sector
3.6 3.52.9
2.2
4.1
-
2.0
4.0
6.0
8.0
SBI ICICI Bank PNB BoB BoI CBK UNBK
2010 2011
Agriculture12%
Services16%
Retail loans19%
Industry48%
NBFC5% Stressed
17%
Non stressed83%
-
10.0
20.0
30.0
40.0
50.0
Industry Services Retail
loans
Agriculture NBFC
Non stressed Stressed
17.3 Total bank credit
9.4 NBFC
20.0 Agriculture
8.8 Retail loans
8.5 Services
23.6 Industry
% of credit under stress
17.3 Total bank credit
9.4 NBFC
20.0 Agriculture
8.8 Retail loans
8.5 Services
23.6 Industry
% of credit under stress
Sector (Rs bn) Outstanding Stressed % sectoral bank credit credit stressed creditCredit to industry (incl real estate) 17,606 4,161 23.6Retail loans 6,912 610 8.8Services (ex real estate & NBFCs) 5,990 506 8.5NBFCs 1,739 164 9.4Agriculture 4,527 905 20.0Total 36,774 6,347 17.3
4,161610
506 164
905 6,347
0
1,700
3,400
5,100
6,800
Industrycredit
Retail loans Services NBFCs Agriculture Total
(Rs bn)
Corporate loans pose the biggest risk, followed by
agriculture
9 | OCTOBER 2011 IDFC SECURITIES
We see ‘restructured loans plus NPAs peaking at 7.8% in FY13
We believe that not all the stressed assets would convert into slippages (NPAs + restructured assets) and also that it would accrue to banks in a staggered manner over the next 2-3 years. Further, we believe that 60% of this incremental stress in likely to play out in FY12 as the impact of slower growth manifests. The remaining 40% is expected to spill over to FY13. In our base case scenario, we expect 50% of the stress to manifest over two years and NPAs + restructured loans to peak in FY13 at 7.8%. This scenario factors in peaking of inflation and interest rates over the next six months, led by softening commodity prices. Given the fact that we do not expect a broad-based recession in the economy, we expect maximum of these to get restructured and not slip into NPAs, which would limit the rise in credit costs for banks. We deduce that asset quality is under duress, but see the deterioration to be manageable.
Exhibit 11: Scenario analysis – gross NPAs to peak at 7.8% in FY13E in our base case
Base case Best case Worst case (50% of stressed debt) (25% of stressed debt) (75% of stressed debt) (Rs bn) FY12E FY13E FY12E FY13E FY12E FY13E Opening Gross NPAs 2,214 3,454 2,214 2,834 2,214 4,074 Allocation of incremental NPAs over yrs (%) 60.0 40.0 60.0 40.0 60.0 40.0 Additions 1,240 827 620 413 1,860 1,240 Closing Gross NPAs 3,454 4,280 2,834 3,247 4,074 5,314 Bank Credit 46,476 54,842 46,476 54,842 46,476 54,842 yoy growth (%) 18.0 18.0 18.0 18.0 18.0 18.0 Gross NPAs (%) 7.4 7.8 6.1 5.9 8.8 9.7 Source: RBI, IDFC Securities Research
In adversity lies opportunity
Reflecting the concerns around the NPA cycle and the global economic turmoil, financials stocks have corrected sharply since August 2011 - down 20% - and are trading at a discount to historical averages. We see current valuations adequately factoring in the risk of higher interest rates (lower credit growth and contraction in NIMs) as also slower economic growth (asset quality deterioration).
Historically, a strong rebound seen on normalization in macros
The previous downcycle of 2008 also saw a steep correction in financials stocks, triggered by an acute liquidity crunch in the global as well as domestic markets. Interest rates had increased rapidly and GDP growth plummeted to sub-6% levels. Stocks had touched lows of ~0.5x one-year forward book. At the time, stocks were pricing in NPAs of 10%+ for PSU banks and 8-10% for private banks (Axis Bank and ICICI Bank). However, there was a swift rebound seen in stock prices on the first signs of a decline in interest rates and easing of liquidity.
We expect interest rate and inflation to peak and
commodity prices to soften in next 6 months
We believe the risks of higher interest rates and slower economic growth are adequately priced in
10 | OCTOBER 11 IDFC SECURITIES
Exhibit 12: SBI rebounded sharply as the cycle reversed
0.0
0.8
1.5
2.3
3.0
Apr/06 Apr/07 Apr/08 Apr/09 Apr/10 Apr/112.0
4.0
6.0
8.0
10.0State Bank of India - Price to Adj. Book Value (x) 10 yr G-Sec
Source: Bloomberg
Though the contours of the prevailing economic sluggishness are materially different from 2008, a whiff of ‘normalisation’ of macroeconomic factors is bound to lead to a sharp upmove in financials stocks.
Worsening of the global economy – a risk
Stocks are currently trading well above their past trough valuations and further downside triggered by worsening of the global economy cannot be ruled out in the near term. Also, the next earnings season (Q2FY12) would likely be volatile, and higher delinquencies and earnings downgrades could trigger further correction in stock prices. However, we believe upside potential outweighs the downside risk and do not expect valuations to relapse to past troughs. In our view, any downside emerging due to such factors would be short-lived and should be used to build further positions in these stocks.
‘Disbelief’ + ‘Deep value’ to offer highest returns
A recovery in the economy is likely to trigger a U-turn in financials stocks – expected to be led by sector bell-weathers like SBI, HDFC Bank, HDFC and ICICI Bank. Also, PSU banks - trading at higher discounts to long-term average valuations (15-30%) - are likely to offer higher returns vis-à-vis private peers (10-20% discount to long-term averages). However, as the economy returns to stability, we expect higher beta stocks to outpace sector gains over next 12-18 months. As such, we expect stocks with the steepest discount to long-term valuations and pricing in the highest profitability erosion to outperform over the next 12-18 months.
Stocks which are pricing in the highest decline (in % terms) in RoAs are – BoB, PNB, Union Bank Canara Bank and OBC among PSU banks; and ICICI Bank, Axis Bank, Yes Bank and IndusInd among private ones. Of these, stocks trading at the highest discount to their long-term average offer the most favorable risk-reward. In this light, we identify Union Bank, Canara Bank, OBC, PNB, Axis Bank, Yes Bank and ING Vysya Bank as high beta stocks where the market has ‘disbelief’.
Valuations will not dip to previous troughs, though there is room for some
further downside
A stock rebound is likely to be led by bellwethers
like SBI, HDFC Bank, HDFC and ICICI Bank
Union Bank, Canara Bank, OBC, Axis Bank and Yes
Bank offer the most favorable risk-reward
11 | OCTOBER 2011 IDFC SECURITIES
Exhibit 13: Valuation summary
Valuations - P/BV (x) FY13 ROA disc to Dividend Current 12m fwd LT average Max Min Discount to Discount to estimates (%) yield (%) LT avg (%) max (%) bp % PSU Banks Bank of Baroda 1.2 1.1 2 0.5 5 (41) (62) (50) 2.5 Bank of India 0.9 1.3 2.2 0.6 (26) (58) (24) (29) 2.4 Punjab National Bank 1.1 1.3 1.9 0.6 (16) (41) (64) (49) 2.9 State Bank of India 1.1 1.4 2.5 0.7 (20) (54) (16) (16) 1.6 Union Bank of India 0.9 1.2 1.8 0.7 (23) (48) (58) (53) 3.6 OBC 0.7 0.9 1.4 0.3 (25) (53) (64) (58) 3.5 Allahabad Bank 0.7 0.9 1.5 0.3 (20) (51) (63) (57) 4.5 Canara Bank 0.8 1.1 1.9 0.5 (27) (56) (86) (66) 2.4 Corporation Bank 0.7 1 2 0.4 (36) (67) (49) (51) 4.9 Indian Bank 0.8 1 1.8 0.4 (14) (53) (109) (69) 4.1 PVT Banks Axis Bank 1.8 2.3 4.5 0.7 (23) (61) (35) (22) 1.5 HDFC Bank 3.4 3.4 5.2 1.7 - (35) (13) (8) 0.8 ICICI Bank 1.7 1.9 3.3 0.6 (12) (49) (44) (27) 1.8 Yes Bank 1.9 2.6 5.1 0.5 (27) (64) (23) (16) 0.9 IndusInd Bank 2.5 1.8 3.3 0.5 38 (25) (34) (22) 0.9 ING Vysya Bank 1.2 1.4 2.5 0.6 (14) (51) (37) (33) 1.1 Source: IDFC Securities Research, Bloomberg
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 0.71 0.62 Implied pre-tax ROA 1.01 0.89 Implied Decline from our est 0.76 0.88 Of this: Assumed decline in NIMs 0.20 0.20 Of this: Assumed Rise in provisions 0.56 0.68 At coverage of : 70% 70%Addition to GNPA (% of assets) 1.12 1.31 Addition to GNPA (% of loans) 1.77 2.09 Total GNPA outstanding (%) 1.38 3.15 5.24 yoy rise (%) 128.6 66.2 Total GNPA outstanding (Rs m) 31,525 86,469 169,585 yoy rise (%) 174.3 96.1
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 0.50 0.44 Implied pre-tax ROA 0.63 0.55 Implied Decline from our est 0.93 1.09 Of this: Assumed decline in NIMs 0.15 0.15 Of this: Assumed Rise in provisions 0.78 0.94 At coverage of : 70% 70%Addition to GNPA (% of assets) 1.48 1.68 Addition to GNPA (% of loans) 2.33 2.62 Total GNPA outstanding (%) 1.45 3.79 6.41 yoy rise (%) 160.5 69.2 Total GNPA outstanding (Rs m) 30,892 95,977 194,405 yoy rise (%) 210.7 102.6
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 0.58 0.50 Implied pre-tax ROA 0.86 0.75 Implied Decline from our est 1.41 1.63 Of this: Assumed decline in NIMs 0.30 0.35 Of this: Assumed Rise in provisions 1.11 1.28 At coverage of : 70% 70%Addition to GNPA (% of assets) 2.04 2.33 Addition to GNPA (% of loans) 3.31 3.76 Total GNPA outstanding (%) 0.98 4.29 8.05 yoy rise (%) 336.1 87.6 Total GNPA outstanding (Rs m) 7,403 39,065 87,934 yoy rise (%) 427.7 125.1
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 1.25 1.18 Implied pre-tax ROA 1.72 1.63 Implied Decline from our est 0.31 0.60 Of this: Assumed decline in NIMs 0.20 0.25 Of this: Assumed Rise in provisions 0.11 0.35 At coverage of : 70% 70%Addition to GNPA (% of assets) 0.69 1.03 Addition to GNPA (% of loans) 1.27 1.86 Total GNPA outstanding (%) 4.48 5.75 7.61 yoy rise (%) 28.3 32.4 Total GNPA outstanding (Rs m) 96,926 146,242 230,135 yoy rise (%) 50.9 57.4
38 | OCTOBER 11 IDFC SECURITIES
Income statement
Year to 31 Mar (Rs m) FY09 FY10 FY11 FY12E FY13E Net interest income 83,666 81,144 90,169 104,486 131,907 yoy growth (%) 14.5 (3.0) 11.1 15.9 26.2
Other income 76,037 74,777 66,479 75,749 87,405
yoy growth (%) (13.7) (1.7) (11.1) 13.9 15.4
Trading profits 4,430 11,810 (2,150) 1,500 2,500
Non trading income 71,607 62,967 68,629 74,249 84,905
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 0.80 0.74 Implied pre-tax ROA 1.22 1.13 Implied Decline from our est 0.34 0.56 Of this: Assumed decline in NIMs 0.30 0.30 Of this: Assumed Rise in provisions 0.04 0.26 At coverage of : 70% 70%Addition to GNPA (% of assets) 0.46 0.82 Addition to GNPA (% of loans) 0.73 1.31 Total GNPA outstanding (%) 2.34 3.08 4.39 yoy rise (%) 31.3 42.5 Total GNPA outstanding (Rs m) 5,532 9,137 16,377 yoy rise (%) 65.2 79.2
Year to 31 March (%) FY11 FY12E FY13EImplied ROA 1.45 1.24 Implied pre-tax ROA 2.19 1.87 Implied Decline from our est (0.01) 0.34 Of this: Assumed decline in NIMs 0.05 0.15 Of this: Assumed Rise in provisions (0.06) 0.19 At coverage of : 70% 70%Addition to GNPA (% of assets) (0.00) 0.41 Addition to GNPA (% of loans) (0.01) 0.69 Total GNPA outstanding (%) 0.23 0.23 0.92 yoy rise (%) (2.4) 302.7 Total GNPA outstanding (Rs m) 803 1,019 5,334 yoy rise (%) 26.8 423.5
Cash & bank balances 19,227 26,732 34,960 41,535 53,324
Total assets 229,008 363,825 590,070 769,537 980,073
Networth 16,242 30,895 37,941 46,296 57,235
Deposits 161,694 267,986 459,389 601,917 771,315
- Current % 7.5 9.1 8.6 10.0 11.0
- Savings % 1.2 1.5 1.8 1.5 2.0
- Term % 91.3 89.5 89.7 88.5 87.0
Borrowings 37,017 47,491 66,909 90,327 117,425
Key valuation metrics
Year to 31 Mar (Rs m) FY09 FY10 FY11 FY12E FY13E Net profit (Rs m) 3,038 4,777 7,271 9,830 12,870
yoy growth (%) 51.9 57.2 52.2 35.2 30.9
Shares in issue (m) 297.0 339.7 347.1 347.1 347.1
EPS (Rs) 10.2 14.1 20.9 28.3 37.1
EPS growth (%) 47.2 37.5 48.9 35.2 30.9
PE (x) 27.7 20.1 13.5 8.7 6.6
Adj. Book value (Rs/share) 54.2 91.1 109.7 134.0 166.3
P/ Adj. Book (x) 5.2 3.1 2.6 1.8 1.5
RONW (%) 20.6 20.3 21.1 23.3 24.9
Ratio analysis
Year to 31 Mar (%) FY09 FY10 FY11 FY12E FY13E Net int. margin/avg assets 2.6 2.7 2.6 2.5 2.6
Non-fund rev./avg assets 2.2 1.9 1.3 1.1 1.1
Operating exp./avg assets 2.1 1.7 1.4 1.3 1.2
Cost/Income 44.2 36.7 36.3 35.1 34.2
Prov./avg customer assets 0.4 0.4 0.1 0.1 0.1
PBT/Average assets 2.3 2.5 2.3 2.2 2.2
RoA 1.5 1.6 1.5 1.4 1.5
RoE 20.6 20.3 21.1 23.3 24.9
Tax/PBT 34.8 34.2 33.4 33.5 33.5
Tier I Capital adequacy 9.5 12.8 9.7 8.9 8.3
Growth in customer assets 35.8 72.1 66.2 25.2 26.8
Growth in deposits 21.8 65.7 71.4 31.0 28.1
SLR ratio 26.5 23.4 21.8 24.0 24.0
CASA ratio 8.7 10.5 10.3 11.5 13.0 Shareholding pattern (%)
Foreign53.7%
Public & others11.3%
Non-promoter corporate holding1.6% Institutions
7.0%
Promoters26.5%
As of June 2011
45 | OCTOBER 2011 IDFC SECURITIES
THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK
46 | OCTOBER 11 IDFC SECURITIES
THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK
47 | OCTOBER 2011 IDFC SECURITIES
Disclaimer
This document has been prepared by IDFC Securities Ltd (IDFC SEC). IDFC SEC and its subsidiaries and associated companies are a full-service, integrated investment banking, investment management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable. While we would endeavor to update the information herein on reasonable basis, the opinions and information in this report are subject to change without notice and IDFC SEC, its subsidiaries and associated companies, their directors and employees (“IDFC SEC and affiliates”) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance, or other reasons that may prevent IDFC SEC and affiliates from doing so. Thus, the opinions expressed herein should be considered those of IDFC SEC as of the date on this document only. We do not make any representation either express or implied that information contained herein is accurate or complete and it should not be relied upon as such. The information contained in this document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is prepared for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The investment discussed or views expressed in the document may not be suitable for all investors. Investors should make their own investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved) and investment decisions based upon their own financial objectives and financial resources. Investors assume the entire risk of any use made of the information contained in the document. Investments in general involve some degree of risk, including the risk of capital loss. Past performance is not necessarily a guide to future performance and an investor may not get back the amount originally invested. Foreign currency-denominated securities are subject to fluctuations in exchange rates that could have an adverse effect on the value or the price of, or income derived from, the investment. In addition, investors in securities, the values of which are influenced by foreign currencies, effectively assume currency risk. Affiliates of IDFC SEC may have issued other reports that are inconsistent with and reach different conclusions from, the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject IDFC SEC and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to a certain category of investors. Persons in whose possession this document may come are required to inform themselves of, and to observe, such applicable restrictions. Reports based on technical analysis centers on studying charts of a stock's price movement and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals. IDFC SEC and affiliates, their directors, officers, and employees may from time to time have positions in, purchase or sell, or be materially interested in any of the securities mentioned or related securities. IDFC SEC and affiliates may from time to time solicit from, or perform investment banking, or other services for, any company mentioned herein. Without limiting any of the foregoing, in no event shall IDFC SEC, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind including but not limited to any direct or consequential loss or damage, however arising, from the use of this document. Any comments or statements made herein are those of the analyst and do not necessarily reflect those of IDFC SEC and affiliates. This document is subject to changes without prior notice and is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material and is not for any type of circulation. Any review, retransmission, or any other use is prohibited. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. IDFC SEC will not treat recipients as customers by virtue of their receiving this report. IDFC Capital (USA) Inc. has reviewed the report and, to the extent that it includes present or past information, it is believed to be reliable, although its correctness cannot be assured.
Additional Disclosures of interest: 1. IDFC SEC and its affiliates (i) may have received compensation from the company covered herein in the past twelve months for investment banking services; or (ii) may expect to receive or
intends to seek compensation for investment-banking services from the subject company in the next three months from publication of the research report. 2. Affiliates of IDFC SEC may have may have managed or co-managed in the previous twelve months a private or public offering of securities for the subject company. 3. IDFC SEC and affiliates collectively do not hold more than 1% of the equity of the company that is the subject of the report as of the end of the month preceding the distribution of the research
report. 4. IDFC SEC and affiliates are not acting as a market maker in the securities of the subject company. Explanation of Ratings: 1. Outperformer : More than 5% to Index 2. Neutral : Within 0-5% (upside or downside) to Index 3. Underperformer : Less than 5% to Index Copyright in this document vests exclusively with IDFC Securities Ltd.