No PSU bank stock rose in 2023 so far after a stellar 2022; should you buy or stay away?

After a stellar 2022, no PSU bank stock has given positive returns in the current calendar year so far. This is despite a healthy increase in margins, strong loan growth and continued benign asset quality trends.

"The banks' earnings are indicative of a favorable operating environment, which is the best seen in the last decade. Despite this, the banking stocks trade well below their decade's peaks and even below their 10-year average PBx for some" noted brokerage house Bernstein. However, it added that there are no major risks to expectations of mid-teens RoEs and credit growth that could justify this anomaly. The subdued valuations, despite strong operating metrics, make the risk-reward picture for the Indian banks rather compelling, it forecasted.

In 2023, the Nifty PSU Bank index has fallen over 13 percent with all its constituents in the red. Meanwhile, in the last 1 year, the index has given over 40 percent returns to its investors.

In a recent note, brokerage house Emkay pointed out that the fundamentals of the banking industry are intact amid macro concerns and the Adani saga, providing an entry point in the recent correction. It also states that the overall credit growth remains strong but the deposit growth needs to pick up the pace.

Rahul Malani, Deputy VP, Fundamental Research at Sharekhhan by BNP Paribas, also stated that the overall underperformance in PSU banks is attributable mainly to the Adani Group-Hindenburg saga. The street is fearing the worst-case scenario as far as Adani conglomerate’s debt exposure is concerned, which is not the ideal case as most of the banks' debt exposure to the Adani Group was secured by completed and cash-generating assets. In the near term, volatility may be there in the PSU banks' stocks till some more clarity emerges and the situation normalises, he added.

Stocks

In the last month as well, all except 2 PSU bank stocks were in the red. SBI and Bank of Baroda are the only 2 stocks that ended in the green in Feb.

In 2023, Indian Overseas Bank and Punjab & Sind Bank have shed the most, down over 20 percent, followed by Union Bank, UCO Bank, CBI, and Bank of India, down between 15 percent and 20 percent.

UCO Bank which surged 122 percent in the last 1 year has shed over 15 percent in 2023 YTD. Similarly, Indian Bank which advanced 85 percent in the last 1 year is down 7.5 percent this year.

Punjab & Sind Bank, Union Bank of India, Bank of Baroda, and Bank of India, all surged over 50 percent each in the last one year but have lost between 13 and 22 percent in 2023 YTD.

Outlook

Going ahead, Malani believes that banks should see some moderation in loan growth due to a higher base in FY24 but it is expected to remain healthy. Margins are likely to improve led by a delay in rate hike pause, improving retail mix partly offset by an increase in the cost of deposits, however, margin expansion is expected to moderate and they are expected to peak out by the end of FY2024 on the base case that another 50 bps rate hike is on cards. Asset quality outlook continues to remain stable to positive for the sector, he stated.

His top picks in the sector include:

Private Banks – ICICI Bank, Axis Bank, HDFC Bank, Kotak Bank, Federal Bank, and AU Small Finance Bank

PSBs – SBI, Bank of Baroda and Punjab National Bank.

Vinit Bolinjkar- Head of Research - Ventura Securities, noted that weak global demand and monetary tightening by the central bank have impacted the economic growth outlook for PSU banks for the near term. Going ahead, he predicts that the RoA (return on assets) for large PSU banks is seen inching towards 0.8-1 percent gradually. With a recovery in growth and stable asset quality, PSU banks are set for further re-rating, he added.

Devarsh Vakil, Deputy Head of Retail Research, HDFC Securities, on the other hand, noted that after the strong rally in the latter half of 2022, there has been profit booking in PSU bank stocks.

"Increasing interest rates have impacted the growth momentum. Credit growth has started to see some deceleration but we are sanguine on the prospects in the medium term," Vakil forecasted.

He further mentioned that RBI has increased repo rates by 250bps and banks continue to pass on the increased cost, driving higher yields and NIM expansion. Asset quality outlook also remains encouraging and credit costs are expected to remain stable. Banks with higher CASA ratios would benefit from increasing interest rate scenarios, he highlighted. Vakil is positive on Axis Bank, ICICI Bank and SBI among larger banks and Federal and City Union Bank among mid-tier banks from stocks under their coverage.

Post the strong outperformance, the banking sector has seen correction in the past few months due to increasing macro/policy concerns and the recent Adani saga. Notwithstanding the macro dislocations, Emkay Global believes the banks are likely to witness healthy credit/earnings growth, with enough capital and provision buffers in place.

As far as the Adani group's exposure is concerned, their discussion with bankers suggests that the risk of default remains remote and low. Emkay Global expects Q4 results to be equally strong for banks, particularly corporate banks benefiting from the reviving growth as well as improving asset-quality resolutions. Emkay Global remains positive on the sector and favors ICICI Bank, Axis Bank, Bank of Baroda, SBI, Federal Bank, Karur Vysaya Bank, and Indian Bank. 

The research house believes HDFC Bank also offers a good defensive bet, while it remains concerned about Kotak Bank's top management change in the ensuing year. It also likes IndusInd Bank, but believes that clarity on the current MD & CEO’s term will be critical for the stock. RBL and Bandhan Bank, too, are expected to report a better 4Q vs 3Q and could see interest from investors.