Private banks now structurally ex-growth, to see continued derating, says Emkay Global; halves weight in model portfolio

The financial services segment is now structurally ex-growth, and the valuations do not fully reflect this. The private banks are running out of levers to improve Return on Assets (ROAs). They are now ex-growth across metrics, including loans, revenues, profits, and Book Value Per Share (BVPS), analysts said.

The major drivers are structural. Extreme risk aversion from both corporate borrowers and lenders has depressed wholesale loan demand. Disintermediation is intensifying as corporates are increasingly accessing the bond market. PSU banks are competing more effectively post-Covid, so easy market share gains for private banks are not forthcoming, Seshadri Sen, Head Of Research And Strategist at Emkay Global Financial Services said in a note.

Emkay Global has halved the weightage of Financials in its model portfolio as it sees continued derating for large-cap private lenders. It slashed weightage on financials to 15% from 30%, with deep cuts in index heavyweights like HDFC Bank, ICICI Bank and SBI, while it has added Axis Bank. 

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The brokerage firm switches to a bottom-up, absolute-return approach for stock picking among lenders. 

“We are looking at three drivers – intrinsic value mismatch, turnarounds, and earnings momentum, while ignoring ‘quality’, historical valuation, and benchmark weights. Our focus remains on large liquid names (large- and mid-cap only). We are also not seeing lenders as defensive-post-Covid history tells us that the sector underperforms during market drawdowns. IT and FMCG are better defensives,” Emkay Global Analysts Seshadri Sen and Arthkumar Gandhi said in a report.

The brokerage firm said its all four picks were now bottom-up:

- Axis Bank, because it thinks the rerating and narrowing of gap with peers will continue, trades at 2x PBV versus 2.4-2.8x for larger peers.

- Shriram Finance, attractive at 1.9x PBV with 17,3% ROE and benefiting from the Commercial Vehicle (CV) cycle.

- IndusInd Bank, trading at 2x BV/15,4% ROE with tailwinds of improving deposit profile and favorable auto/MFI cycle.

- ICICI Prudential Life Insurance Company, is at a discount to peers with positive business momentum under the new leadership.

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Cyclical factors like liquidity constraints and fears about retail asset quality add to the pain. In our view, private sector lenders are now in an extended moderate-growth spell with BVPS growth at 11-16% versus 14-22% ten years ago. The painful adjustment in valuations reflects that. The epicenter of earnings growth has shifted toward manufacturing, putting further pressure on bank stock prices, Sen said.

Meanwhile, the Reserve Bank of India (RBI) has come down heavily on lenders in recent months, in order to control the retail credit build-up and address challenges posed by the rapid rise of digital payments. 

While this is positive from a systemic perspective, the analysts believe this hits banks in two ways - slower growth in profitable segments like unsecured retail, and larger investments in tech, which could push up costs. 

“We believe that investors should factor these macro headwinds into valuations, instead of trying to predict specific regulatory action,” said the brokerage report.

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Moreover, its Gordon Growth model analysis indicates that the intrinsic multiples for private banks have collapsed by 4-63% over the last 10 years. Lower growth and moderating ROEs have depressed fair values, and it finds that the near-halving of multiples for some leading banks is supported by the deterioration of underlying fundamentals. 

“Historical P/BV ranges for private banks now have little predictive value. The derating should continue, in our view, and the valuation ranges for private banks would now settle at 1.5-1.7x (P/BV) with further time correction,” the analysts said.

In the PSU banks, the analysts see individual opportunities based on specific growth strategies and execution capabilities. At 1-1.2x PBV, there is limited rerating scope as growth tapers and ROEs are at risk from capital raising. There are attractive bottom-up opportunities but no compelling top-down case. 

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Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.