Mid Cap private banks - Finding the next Winner - Prabhudas Lilladher

Large number of private banks have succeeded in creating value /setting benchmarks. Competition is only increasing but some mid-cap banks have had management changes and others have reoriented their business models. We benchmark four mid-cap banks, ING Vysya (ING), Federal (FB), South Indian (SIB) and J&K (J&K) v/s larger private/PSU peers on +75 metrics to ascertain relative strengths/weakness and arrive at the next winner. We initiate coverage with a 'BUY' on J&K (+24% upside), ING (+17% upside) and FB (+17% upside) and 'ACCUMULATE' on SIB (~5% upside).

- Benchmarking: Scoring on many metrics: Surprisingly, Mid-cap banks compare well v/s peers on capital (Tier-1 levels), overall return ratios and more importantly asset quality comfort, especially from Infra risks. Liability franchise is a mixed bag with J&K/ING faring well but SIB lagging behind. Fee income is a common worry (excl. ING) and so is branch efficiency, though efficiency metrics is on a improving trajectory, but still is significantly sub-optimal v/s larger private peers.

- J&K best pick; SIB least preferred: J&K (BUY, ~24% upside) enjoys an inherent state CASA advantage and though competition is picking up in J&K, our feedback suggests that it will not be disruptive. J&K Bank is most detached from the current economic slowdown and best positioned to benefit from a booming and under-penetrated J&K state. Valuations is extremely appealing at 0.85x FY14 book, with +20% ROEs and limited asset quality risk. SIB (ACCUMLATE, ~5% upside) also enjoys strong asset quality + robust ROEs. However, with the weakest operating metrics, including liability/NIM/Core fees/branch efficiency, we believe re-rating in case of SIB will be limited.

- Positive on ING and FB: ING (BUY, ~17% upside) and FB (BUY, ~17% upside) both lag on ROEs. However, we believe, issues constraining ROEs will get addressed over the next two years. ING's ~59% cost/income has been a ROA constraint and we believe, management strategy of calibrated branch expansion will aid in bringing C/I lower without impacting growth as ING is the most urban-centric bank with characteristic similar to large banks and hence, branch efficiency catch-up will be significant. FB's legacy asset quality issues have been addressed by the new management and as the legacy book rolls down, credit costs will settle at ~50% lower levels v/s FY09-11 and gradual leveraging up will drive ROE improvement.

- Valuation gap v/s larger private banks will never get bridged but provides significant comfort: Current valuations at 0.8-1.2x for old generation private banks is extremely reasonable, considering limited asset quality issues, especially Infra and improving profitability, though gap in many metrics will never let valuations converge with larger peers. With the ~15-20% move in Financials over last two months, we believe a basket of small private banks provide potential for strong upside +20-25% and also offer downside protection as growth slowdown will be lower + Infra risks is limited.

Source : Equity Bulls

Keywords