Risk reward still favours PSU bank valuations

A stellar run up by PSU banks had all eyes glued towards them. We tried to analyse the factors leading to the rally and what is in store ahead. Bank Nifty gained ~28% whereas PSU banks were up 74% in the last six months (as of December 21, 2022). Post the phase of significantly higher GNPA, treasury MTM losses, lower capital & sub-par growth, there has been a turnaround with comfort on asset quality; reversal of treasury losses, credit growth pick-up and just adequate capital position for most of them. Despite the decent rally, valuation still look reasonable for PSU banks.

PSU bank trends over last few quarters/years:

GNPA, NNPA ratio decline picks up pace in last five quarters

The asset quality trend continued to improve led by healthy recoveries and steady incremental slippages. Absolute GNPA and NNPA declined 16% and 30% YoY, respectively, in Q2FY23 after a similar cut in Q3FY21. GNPA, NNPA ratio for PSU banks declined from 9.4%, 2.4% in Q3FY21 to 6.6%, 1.8% in Q2FY23, respectively. Management comments, revival in the economy suggest an improvement in asset quality and lower credit cost ahead with PCR currently around 75%.

Credit growth back to 20% for PSU banks from low single digits

Loans recorded growth of 20.4% YoY, 4.8% QoQ to Rs 120.4 lakh crore. However, PSU banks saw growth surging to 20.1% in Q2FY23 (including international) from ~3% in Q1FY22. Business momentum is healthy, attributable to robust demand in the retail & MSME segment. Corporate credit grew for most banks including PSU banks. Banking sectoral data (October 2022) shows the retail segment was up 20.2% YoY and agri credit jumped 13.6% YoY. Large corporate credit, which had been a drag on overall banking credit growth, has started to enter the positive territory in the past few quarters. Management commentaries and data indicate a revival in utilisation of working capital (WC) limits. Thus, we believe bank credit growth should continue to remain at 15-16%with PSU banks at 12-15%.

G-sec yields moderating, expect stabilisation

Treasury losses amid a run up in yields impacted the improvement in operational performance in Q1FY23. However, the recent decline in yields from 7.5% to 7.3% is expected to reverse these losses, which no longer seems an overhang for PSU banks.

Margins, PAT, return ratios going northwards

PSU banks reported 20% YoY and 13.6% QoQ growth in NII, highest in last eight quarters. Faster transmission of rate hikes on assets compared to liabilities and healthy proportion of low cost deposits led to strong sequential rise in margins (10- 40 bps QoQ). Management commentary suggests margins will remain steady at the current level in H2FY23. Led by a strong topline and lower credit cost, net profit of PSBs grew 19% YoY and 70% QoQ at Rs 26,021 crore for Q2FY23 depicting improving earnings. Hence, with expected sustainability of earnings growth, return ratios are improving. RoA has reached 0.6-0.8% in Q2FY23 similar to FY14-15 levels. We expect further improvement in RoA though RoE may take longer to surge, except for SBI, BoB, Indian Bank and Canara Bank where >11% RoE is reached.

Valuations still reasonable

Going ahead, the RoA for large PSU banks is seen inching towards 0.8-1% gradually. With a recovery in growth and stable asset quality, PSU banks are set for a further re-rating. Large PSU banks (SBI, BoB, Canara Bank) are trading at ~0.8-1x P/BV, which paves the way for a further re-rating as peak valuations remain at ~1.2-1.5x in FY12-14. Mid-sized and small banks, currently trading at 0.5-0.7x P/BV, touched ~1x then. We remain positive on PSU banks, with upsides expected to continue in the medium term horizon.

Source: ICICIdirect Research

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