Spark Capital: Regional Private Sector Banks - Sector Report "Re-rating journey - Phase II"
Spark Capital Advisors(India) Private Limited
10 Oct 2012
Available for Immediate Download
Regional Private Sector Banks Re-rating journey – Phase II For almost the entire last decade, valuations of regional private sector banks trended in tandem with that of mid-sized PSU Banks with P/ABV multiples collapsing to as low as 0.5x FY10E ABV during early CY09 in line with most PSU banks’ valuations then. However, in the first two years of this decade, when most PSU bank stocks have revisited their trough multiples, P/ABV multiples of regional private banks have not compressed below 1.1x-1.2x ABV with most stocks having re-rated substantially over this period to trade currently at close to their all-time high prices. In this note, we review (a) whether the factors that led to the re-rating over the past year are sustainable, (b) the potential for further re-rating over the ensuing three years, which can partly bridge the gap in multiples with the new-gen private banks and (c) identify the banks best placed to play this theme with the highest re-rating potential. Conclusion: We opine that while improved asset quality has been the single biggest driver of stock prices for the regional banks over the past couple of years, they are unlikely to be the only re-rating trigger going forward. In our view, the next phase of re-rating will have to driven by improvements in management bandwidth, product & geographical diversification, CASA generation, fee income streams and branch/employee productivity – areas where they rank significantly below new-gen private banks. Regional private banks are a ‘must-have’ in the portfolio given their strong local franchises esp. in upcountry locations, ‘ears-on-the-ground’ credit culture of lending to SMEs giving them an asset advantage not easy to replicate, sufficient exit barriers for the borrowing customers giving them a pricing benefit, business models where the evolution is still ‘WIP’ and most importantly, valuations, which leave scope for significant upside if this transformation continues. While we are positive on the sector as a whole given the likely improving trends on these facets, our top picks are KVB and CUB, where we see the maximum potential for these drivers to play out. GNPAs for the old gen sector were at 1.8% in FY12, the lowest among new gen, PSU and foreign banks. Slippages have trended down, restructured assets are below the levels seen in FY09, exposure to vulnerable sectors reduced over this period and gold loans have gained substantially in proportion, lowering NPA risks. Moreover, industry leading growth on advances and deposits, comfortable T1 capital, improving ALM and concentration risk profiles all played their part in the re-rating story. Despite the significant improvements witnessed, the delta between the new and old gen pack remains; CASA and core fee income will have to head northwards for the gap to bridge. Increasing employee productivity will be key to this next big leap; SIB, CUBK and KVB stand to gain the most in this transition phase while FB and VYSB grapple with asset quality and high costs, respectively. Our BUY ratings on KVB, CUBK, SIB and VYSB stands unchanged and we retain our SELL call on FB as transitional improvements are likely to remain low.