Banks, financials turning attractive again

“Banks and diversified financial are among the few sectors that currently meet all the criteria of strong business model, reasonable valuation, and high near-term earnings visibility,” said Sanjeev Prasad, MD, Kotak Institutional Equities. “Their return ratios have improved dramatically and are better than pre-Covid levels in many cases.”

Capital said the credit growth unexpectedly improved in April — historically a lean month – at 11.3% from the same period a year ago as against 9.7% in March.

Agencies

“Banking is a segment where valuations are attractive and buyable. The market, however, has not discounted the improved performance of banks,” said V K Vijayakumar, chief investment strategist, . “With improving credit demand and sharply reduced provisions, leading banks, particularly the well-capitalized large banks like HDFC Bank, ICICI Bank, SBI, Kotak, and Axis are well placed to benefit from the imminent rise in credit demand.”

Banks and financials have been underperformers in recent years. BSE’s Bankex Index has gained 1.8% in the past year, 16.52% in three years and 54.77% over the past five years. In comparison, the benchmark Sensex has gained 6.6% in the past year, 39.45% in the three-year period and 77.81% in the past five years.

While the lack of broader credit growth has resulted in investors being choosy about banks, the recent underperformance has been on account of foreign investors cutting their overweight rating on the sector. Large lenders such as Kotak,

, HDFC Bank, and Canara Bank have declined between 20% and 25% from their 52-week highs. Most other banks have plunged between 30% and 60%.

The recent slump has, however, resulted in banks’ share valuations, measured by the Price to Book Value (P/B) ratio, turning cheaper. For instance, HDFC Bank, whose P/B used to be above five times, is now at around three times. Analysts said the valuation derating has been despite record profits, growing market share, declining provisions, and net non-performing assets below 1%.

“We believe the recent stock correction has more to do with general macro concerns, including perceived rising risks of stagflation, higher CoE (Cost of Equity) and continued FII selling,” said Anand Dama, senior research analyst at Emkay Global Financial.

“The banking sector is well poised to witness a better post-Covid recovery in growth/asset quality. A higher share of floating-rate books and the ability to pass on rate hikes without much growth dislocation should help banks improve profitability.” ICICI Bank and SBI remain Emkay’s top picks among large banks. It prefers City Union Bank, Karur Vysya Bank and Indian Banks among smaller lenders

“HDFC Bank looks attractive from the valuation perspective, but sub-par core profitability and the merger overhang are near-term concerns,” said Dama.

S Hariharan, head of sales at Emkay Global Financial, said the price ratio of Bank Nifty to Nifty is on the verge of breaking out from a two-and-half year downtrend, suggesting a structural trend change.