While bulls aren’t yet ready to give up on the potential of PSU bank stocks given the sharp earnings turnaround, the case for the underdogs is getting louder as the valuations of PSU banks are at historical highs while private banks are languishing near decade-long lows.
Private banks are trading at a price-to-book (P/B) valuation of 2.3 against the 10-year average of 2.5. On the other hand, the PB of PSU banks is at 1.2 against the long term average of 0.8.
On the 5-year timeframe, all the 12 PSU bank stocks are trading well above their average PB levels while underperformers HDFC Bank and Kotak Mahindra Bank are trading well below their 5-year average PB levels.
Valuations will become all the more important in a bull market like this where greed has overtaken fear to make most stocks look overvalued.
“The only exception among the larger sectors seems to be the financial sector where valuations of most private banks have compressed over the past 2-3 years and valuations of PSU banks have expanded but at reasonable levels over the same period,” said Sanjeev Prasad of Kotak Institutional Equities.
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Market insiders are betting that private banks are now in a much better space to grow rather than some of the PSUs.
“Take some money off PSUs. We are not saying totally exit but get into some of the quality largecap private banks including HDFC Bank. They have clarified that they are not going to give in to lower NIMs just for the sake of deposits. There will be a gradual incline and at a two-time price to book, HDFC Bank seems to be the largecap that can move. We are optimistic on all three – HDFC, ICICI and Kotak,” said Dalal Street veteran Sanjiv Bhasin.
While valuations are a key part of the puzzle for PSUs, there are significant fundamental arguments in their favour. The PSU bank rally is largely attributed to a sharp earnings turnaround on asset quality improvements and attractive valuations.
“PSU banks have also typically enjoyed lower loan-deposit ratios, allowing them to push loan growth. PSU bank credit growth in FY24 is within 2-3ppt of private, against the 8-10 ppt gap in growth seen pre-COVID,” Jefferies said.
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Low-free float of many PSU bank stocks has also contributed to the upside. Take Indian Overseas Bank for example. Its shares have jumped 174% in one year and enjoys the highest PB of 5.45 vs the 5-year average of 1.43 and SBI’s current PB of 2. The re-rating is partly because the government owns about 96.38% stake leaving very little number of shares available for trading in the market.
The demand-supply mismatch can be seen in other PSU banks like Punjab & Sind Bank, UCO Bank and Central Bank of India. Government ownership is more than 90% in all of them.
Jefferies analysts see a rerating potential of 25-30% on PE/PB valuations in PSU bank stocks while Nomura analysts believe the biggest challenge for investing in PSU banks arises from their patchy asset quality track records, where the current benign cycle is in their favour.
“Moreover, PSU banks (barring SBI) do not have material exposure to unsecured retail either, which is the key problem area from an asset quality perspective for the sector, in our view. As far as sensitivity to rate cuts is concerned, PSU banks have similar negative sensitivity to NIMs as the private banks,” Nomura’s Param Subramanian said.
(Data: Ritesh Presswala)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
