Ace investor Rakesh Jhunjhunwala has a penchant for spotting winners in the stock market. So when someone of his stature turns bullish on a certain sector or a stock, it is definitely worth taking a look. At a recent event held in Mumbai, when asked for his thoughts on the banking sector, Jhunjhunwala pointed out that old generation private sector banks were in a good space.
The reason: he expects a huge credit growth in FY19 and FY20 and expects these banks to fare better than PSU banks. “Old generation banks have good pre-provision operating profit,” he said. Old private banks are seeing a constant improvement in their pre-provision profits (PPOP). For example, in the past six consecutive quarters Federal Bank has seen an improvement in PPOP from 325 crore to 557 crore; Lakshmi Vilas Bank has been seeing an uptick over the past five quarters from 125 crore to 199 crore; City Union Bank has seen an improvement in nine of the past 10 quarters from 178 crore to 296 crore.
The improvement in the PPOP can also be attributed to higher net interest margins (NIMs) that these banks have been generating compared with their PSU counterparts. Federal Bank reported a NIM of 3.13% for Q1FY18, while Lakshmi Vilas Bank clocked a NIM of 2.74%. For City Union Bank, the NIM stood at 4.47%. In comparison, for the same quarter, the NIMs of state-owned banks such as SBI, BoB and PNB ranged between 2.3% and 2.6%. “Old private sector banks give out low-ticket loans to MSMEs which usually fetches higher yields,” points out Kajal Gandhi, analyst at ICICI Securities.
Importantly, by staying away from large corporate lending, old private banks have ensured healthy asset quality. Federal Bank and City Union’s net NPAs in the June quarter stood at 1.39% and 1.79%. In the case of PSU lenders, Bank of Baroda, SBI and PNB, the net NPAs were in the range of 5.2-8.7%. Being region-focused, they understand their markets well, which helps them manage their asset quality better.
Provisioning coverage ratio (PCR), that measures the percentage of bad assets that have been provided for, is 50-70% in case of old generation private banks. Jhunjhunwala believes that having a well-provided book should benefit these banks when the credit cycle turns. Gandhi adds that as and when the credit cycle picks up pace, these banks could use their profits to participate in the growth, rather than having to meet incremental provisioning requirements.
Analysts’ estimates show that old private banks could see their earnings grow between 15% and 34%, on an average, over FY17-19. Meanwhile, these banks also have better return ratios than their PSU counterparts. Federal Bank, Lakshmi Vilas and City Union’s RoAs range between 0.8% and 1.5%, while that of PNB, BoB and SBI is less than half a percent. The gap is even starker when RoEs are compared. Among public banks, SBI has the highest RoE of 6.8%, while PNB and BoB have 3.2% and 3.8%. However, City Union’s RoE is the highest at 15%, while that of Federal Bank and Lakshmi Vilas stands at 9.8% and 14.4%.
Valuation-wise these banks are justifiably trading at over 37% premium to the price-to-book multiples of PSU banks. However, compared with Kotak Mahindra Bank and IndusInd Bank, these stocks are trading at a huge discount of 56%. While the latter commands a higher valuation given their enviable retail franchise across India and robust asset quality, the gap shows what these old private banks can achieve both in terms of valuation and business model. But if Jhunjhunwala’s words are anything to go by, then these banks have got what it takes to bridge the gap.