Financials - Sector Update - Hope vs. reality play - Centrum

Hope vs. reality play

Easing domestic factors, steps by the central bank to address issues on asset quality, capital requirement and event-based euphoria (election outcome) have pushed valuations upward. Event based plays can be deceptive, as past data suggests wild swings post election, and as it unwinds, concerns on interest rates, asset quality and capital will re-surface. Our 'election euphoria' analysis suggests a meaningful upside in the bull case, but is likely to get tempered quickly as the stickiness of challenges get recognised. We stick to our base case assumptions and retain preference for ICICI Bank (HOLD), DCB Bank (BUY) and City Union Bank (BUY). Within PSUs, continue to prefer PNB to SBI.

Regulatory & economic changes cause a spurt: Easing twin deficits, moderation in CPI Inflation and macro-recovery underway (as pointed out by rating agencies) have provided comfort on the economy front. Steps to arrest NPAs, address capital issue and ensuring adequate liquidity in the system but at a price by the central bank and the election-led euphoria have forced valuations for the entire universe to swiftly adjust to these expectations.

Concerns partly addressed, but much remains to be done: Limited fiscal room restricts the scope for any material easing in interest rates and fund PSU banks. Referrals made to CDR cell have grown +33% yoy to Rs1.2tn YTD and analysis of financials of stressed sectors (50% of total) indicates feeble recovery. Going by past trends, slippages from the restructured pool have averaged 25% and hence it will be too early for NPA issues to recede. Compliance with Basel III norms, though postponed by one year and effective management can help prevent the risk of frequent dilution and consequently RoEs.

Election euphoria vs. disappointment: The current phase of valuation adjustments - more of re-rating rather than improvement in ground realities - is very different from 2009 or even 2004. Nevertheless, our bull case suggests 21-37% upside from current levels. A bear case could see stocks correct 13-27%. We argue that there is greater probability of the bear case rather than the bull case, for which too many stars need to be aligned. We stick to our earlier preference for ICICI Bank, CUBK and DCB Bank. Tactical ideas with a high-risk-high-return profile are SBIN and smaller, under-owned PSU banks.

Quarterly preview - Expect no major changes: We expect third consecutive quarter of near 15% yoy growth in NII for our coverage universe led by 15.2% yoy growth in loan portfolio and flattish NIM. However, with muted non-interest income, higher operating costs (specifically for PSU banks) and weak asset quality trends, net profit is expected to decline 6% yoy. Housing finance companies will see stable growth, sequential improvement in margins and asset quality. Asset financing companies will continue to face challenges on AuM growth and asset quality. We are building in higher GNPA (+63% yoy) and 7% yoy decline in profits.

Source : Equity Bulls

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