Financials To Lead The Next Rally?

We have seen that every stock market rally has different sectors contributing to market gains. The leadership however keeps revolving. The most important question that interests majority of the investors is: who will lead the next leg of rally that can be expected to take markets to all-time highs? Yogesh Supekar shares insights on the market condition while highlighting the importance of the banking sector stocks in one’s core portfolio 

he banking sector while being one of the most important and strategic sectors for the India growth story is also one of the largest wealth creators for its shareholders. Since June 2022 the banking sector has managed to add approximately ₹492,000 crore in market capitalisation, thus creating a huge amount of wealth for investors. Indeed, the banking sector is at the heart of the growth action in the one of the fastest growing economies of the world. The India growth story is intertwined with the banking growth story and the growth story of the economy, and the banking sector is somehow connected to the increasing digitisation story in India. 

Experts argue that digitisation has given the early adopters of technology in the banking sector an unparalleled advantage. The same can be said about the Indian economy. Digitisation is a megatrend in India and is seen influencing consumers across the sector i.e. digitisation is not only influencing consumer decisions as to how to consume products but is also seen influencing what products to consume. Digitisation is thus pushing consumerism and helping accelerate the India growth story in its own unique way. 

The banking sector, during the pandemic, was challenged with various issues including rising NPAs. What followed postpandemic has taken investors by a huge surprise. The banking sector along with the automotive sector has managed to climb the wall of worry much faster and in a smarter way than most investors would have imagined. For instance, who would have thought that the BSE Auto index would hit a fresh all-time high in 2022 amidst talks of the sector being in turmoil? Similarly, to expect Bank Nifty to outperform BSE Sensex was not easy at the beginning of the year even though some market observers believed that Bank Nifty could easily outperform BSE Sensex given the recent underperformance. 

Bank Nifty is up by more than 7 per cent on YTD basis while BSE Sensex remains flat in the similar period. Says Shirish Sonawane, a long-term investor with preference for banking stocks: “I have been holding ICICI Bank and HDFC Bank in my portfolio for quite some time now and I have a clear strategy to accumulate private banking stocks on every dip. I successfully added a small quantity of these quality private banks during the market fall in the midst of the pandemic i.e. in March 2020 and then again added a small quantity in March 2022, May 2022 and June 2022. I could use these dips effectively only because of my high conviction in the banking sector doing well in India going forward.” 

“How can you ignore the sector that is at the heart of lending in a nation that is capital-starved? I have leading private banks and a couple of PSU banks as a part of my core portfolio. I do not think I will be booking profit any time soon even if I am getting multibagger returns in leading private banks. There are multiple triggers for the sector to do well be it digitisation, use of technology or gaining market share by private banks. I have no doubt that private banks should play a role of core portfolio,” he adds. 

Private Banks or PSU Banks

The performance of private banks has been superior when compared to PSU banks on the bourses but of course there are investors who swear by value investing and believe that there is lot of hope in PSU banks. PSU stocks can be seen as value stocks with attractive dividend yields. On ground the situation is improving for PSU banks with NPAs under control and most importantly the earnings showing a consistent uptick. Such consistent earnings from PSU banks can attract long-term investors. 

On the other hand, private banks are already on a growth trajectory and are seen delivering consistent growth in earnings. However, the set of private banks is high in demand amongst institutional investors and the stocks are hence trading with a premium. The valuations of private banks cannot be said to be cheap. Private sector banks have an edge over PSU banks on several counts, one of them being a steady jump in fee income in private banks. If we go by the recent Quarterly Results, IDFC First Bank managed to declare a sharp jump in its fee income. Private sector banks also reflect a better CASA accretion if we go by the recent quarterly results. Strong CASA (current account-savings account) accretion is the key to aid margin expansion in banks. It is famously said that CASA is the lifeline for banks. 

Commenting on the performance of IDFC First Bank, Chief Financial Officer and Head – Corporate Centre Sudhanshu Jain says, “The bank has developed a robust business model with strong core earning power and profitability. The incremental business profitability economics is so strong that it is pulling up the overall profitability every quarter as is evident from the significant improvement in the return ratios quarter on quarter. Our bank’s Q1FY23 results show a strong growth trend in profitability with ROA now touching ~1 per cent. Business growth including assets and deposits has been strong and the bank has maintained the CASA ratio at a level of ~50 per cent which is better than the industry average. This has helped the bank to have a strong and steady net interest margin of around 6 per cent. The bank also has a very well-diversified fee income base which has just started firing up and would bring higher income levels going forward.” 

Apart from the CASA accretion and the jump in fee income, the loan book growth remains strong for the private banks, thus giving them an edge over the PSU banks. There is recovery in the loan book growth in PSU banks; however, the private banks have shown consistent and steady growth in loan book growth, thus facilitating better valuations in the long run. High capital adequacy ratio is also an advantage possessed by the private banks. High capital adequacy ratio provides buffer for future growth and thus with high capital adequacy ratio the private banks again stand to gain when compared to their PSU peers. 

We observe that some of the private banks like Axis Bank are churning their books towards high-yielding segments. Axis Bank’s market share in net credit cards added has improved dramatically after a lean CY20. The acquisition of Citibank India’s retail business can add value for Axis Bank in the coming quarters. The table below highlights the Q1FY23 results for banks and NBFCs that beat estimates: 

While private banks are a step ahead of the PSU banks on most parameters, some of the PSU banks have shown overall improvement in business performance. Bank of Baroda, for example, has shown better than expected improvement in terms of asset quality. Gross NPA additions were to the extent of ₹ 43.52 billion (annualised NPA addition ratio of 1.7 per cent) and recoveries and upgrades were also healthy at ₹ 25.99 billion. The global NIM at 3.02 per cent de-grew from -6 bps / -2 bps QoQ / YoY as the fall in yield on advances QoQ was higher than the fall in cost of deposits for Bank of Baroda. On the asset growth front, the whole bank advances grew 2.6 per cent / 18 per cent QoQ / YoY driven sequentially by domestic retail and international loans. 

The fee income however saw a dip for the PSU bank, driven sequentially lower due to seasonality in business. The fee income for Indian Bank also saw a dip this season while the NIM was reported at 3.10 per cent, up by 23 bps / 25 bps QoQ / YoY. NIM improvement was driven sequentially by higher yield on advances and lower cost of deposits. Indian Bank reported growth in advances driven sequentially by agricultural and overseas loans. For Federal Bank the CASA ratio improved to 36.94 per cent. Federal Bank showed improvement in NPA ratios with GNPA declining by 61 bps to 2.80 per cent and NNPA by 23 bps to 0.96 per cent. 

Contribution of the Banking Sector

Ever since the market made near-term bottom in mid-June, we have seen several stocks bounce back impressively, thus creating wealth for shareholders. The market-cap of BSE-listed companies is hovering around an all-time high. Apart from the Adani Group stocks that were seen contributing the most to market-cap addition we find that the banking sector as a group, especially the private banks, contributed handsomely to the market-cap gains. The banking sector was one of the leading sectors in the recovery phase and managed to create huge amount of wealth for investors during this recovery period, which pushed BSE Sensex higher by 16 per cent and Bank Nifty higher by 19.5 per cent. ICICI Bank added a whopping ₹ 127,317.68 crore to its market-cap followed by HDFC Bank and SBI which added ₹ 114,292.91 crore and ₹ 70,861.41 crore, respectively. Private sector banks clearly and once again managed to create more wealth for investors when compared to their PSU peers. The table below explains the amount of wealth created by the private banks versus the PSU banks during the recent recovery in the markets:

"The bank has developed a robust business model with strong core earning power and profitability. The incremental business profitability economics is so strong that it is pulling up the overall profitability every quarter as it is evident from the significant improvement in the return ratios quarter on quarter. Our bank’s Q1FY23 results show a strong growth trend in profitability with ROA now touching ~1 per cent. Business growth including assets and deposits has been strong and the bank has maintained the CASA ratio at a level of ~50 per cent which is better than the industry average. This has helped the bank to have a strong and steady net interest margin of around 6 per cent. The bank also has a very well-diversified fee income base which has just started firing up and would bring higher income levels going forward."
 

— Sudhanshu Jain


Chief Financial Officer and Head – Corporate Centre, IDFC First Bank 
 

"Banking system saw good loan growth at 2.3% QoQ (usually Q1 sees a dip) as business momentum continued. Our coverage banks witnessed slightly better loan growth at 2.6% largely led by SBI, ICICI, HDFCB and BoB. NIM was a tad better at 3.65% (+8bps QoQ) and hence NII growth at 4.0% QoQ exceeded loan growth. Other income declined sharply by ~40% QoQ led by treasury loss of RsRs95bn (mainly SBI, HDFCB, BoB and AXSB) while fees and recovery income was a tad better. Core PPoP was flat QoQ at Rs661bn as opex was higher. Asset quality was mixed; while slippages were higher, provisions were lower protecting PAT. As a result, core PAT beat estimates by 8.3% to Rs354bn (+7.3% QoQ). ICICI, Kotak, Indusind, FB and CUBK saw a strong quarter. NIM would be the key monitorable as repo has been hiked by 140bps YTD and banks with higher EBLR linked loans and positive ALM would benefit. "
 

— Prabudas Liladhar
 

FIIs are Buying Financial Services Stocks 

Looking at the improving credit cycle, signs of recovery in capital expenditure (capex) and rising asset quality FIIs have increased their exposure to banking and finance stocks.

FIIs have invested over $1 billion in financial in the past one month which tantamount to one-fourth of the total $4.5 billion that was poured into Indian equities in similar period if we go by the data from NSDL.

After June 2021 we have seen such heavy allocation to the financial services sector by the FIIs.

Between October 2021 and June 2022 FIIs sold financial stocks worth $14 billion when the overall sell figure stood at $33 billion.

Financial services stocks weightage is 24.8 per cent in the MSCI India index- a gauge used by global fund managers to benchmark the performance of Indian equities. 

Conclusion 

The Indian markets are in a sweet spot with the growth engine in full swing. Normal monsoons will help boost the market sentiments and firm crop and dairy prices can be expected to help revive the rural demand in spite of rising inflation. Corporate profitability is also on the rise and the coming quarters are expected to be keep investors busy owing to early festival season and strong urban discretionary demand. Due to softening global commodity prices the margins are also expected to improve for corporate India. Positive FII flows amidst subsiding fears of recession augur well for the Indian equities. 

"Listening to uninformed people is worse than having no answers at all." 

Ray Dalio
Principles: Life and Work 

Although US Federal Reserve and other central banks remain hawkish given 40-year high inflation and structural issues in curtailing inflation on account of the Russia-Ukraine war, the markets seem to be discounting a mild slowdown or recession and not a deep and prolonged correction. This is helping the market maintain healthy momentum. The banking sector is in a favourable position and is one sector that stands to gain from the current situation in the Indian equity markets. If we consider the Nifty weightages, almost 40 per cent weightage is assigned to financial services that include both private banks and PSU banks. 

The financial sector is expected to play an important role in the India growth story simply because the aggressive growth in India needs ‘aggressive growth financing’. There is huge opportunity for the financial services and banking sector in India if one looks at the bigger picture. If we consider a top-down approach of investing, the banking sector or the financial sector in India looks promising as multiple growth triggers are in place at the sector level. The challenge remains to identify stocks within the financial or banking sector that may outperform the sector. 

To choose winners from the banking space it will be useful to focus on capital adequacy ratio, expansion strategy, increasing footprints (both digital and physical), healthy NIMs, credit growth and presence in high-margin businesses. Focus also should be on various growth initiatives taken by the banks, either organic or inorganic. Unlike in the US markets where banking majors have underperformed IT stocks as measured by NASDAQ performance, the Indian banks are relatively well-placed and are seen outperforming the markets. Banks and financials can be expected to lead the next leg of the rally which may take the markets to all-time high levels. 

For banks in India, growth continues to improve across segments even though retail remains the growth driver for most banks. It may be a good idea to include those banks in the portfolio which have higher market shares in the retail segment. Definitely it is the large PSU banks and private banks that benefit from such high market share in the retail segment. There are signs of slight uptick in corporate credit growth while improvement in overall economic environment is expected to be partially nullified by higher inflation and geopolitical tensions. Owing to the rising interest rates, usually the finance companies tend to report better margins. 

However, we will have to wait for the next quarterly results to assess the situation better on the margin front. Meanwhile, even though overall asset quality improvement is being witnessed, the slippages are slightly higher this quarter, indicating existence of some asset quality pressure. Buying by FIIs has been directed to the financial sector in India since mid-June this year. The financial sector is one sector that has attracted FIIs a lot ever since they have started participating in the Indian equity markets. In fact, the financial sector is one sector that provides length (number of stocks) and breadth (volumes) for FIIs. 

Attractive valuation and rising fund flows from the institutional investors will keep the banking space in the spotlight over the coming months. Also, banks have been amongst the biggest underperformers since the first wave of the pandemic. Factors like healthy balance-sheets, revival in credit growth and current interest rate scenario augur well for strong banks. Long-term investors can park funds in some of the leading private and PSU banks in the coming months. Elaborating about the current wave in the banking sector, investment consultancy firm Prabhudas Liladhar has this to say: “The banking system saw good loan growth at 2.3 per cent QoQ (usually Q1 sees a dip) as business momentum continued. Our coverage of banks witnessed slightly better loan growth at 2.6 per cent largely led by SBI, ICICI, HDFCB and BoB.” 

“NIM was a tad better at 3.65 per cent (+8 bps QoQ) and hence NII growth at 4 per cent QoQ exceeded loan growth. Other income declined sharply by ~40 per cent QoQ led by treasury loss of ₹ 95 billion (mainly SBI, HDFCB, BoB and AXSB) while fees and recovery income was a tad better. Core PPoP was flat QoQ at ₹ 661 billion as operational expenses were higher. Asset quality was mixed while slippages were higher and provisions were lower, thus protecting PAT. As a result, core PAT beat estimates by 8.3 per cent to ₹ 354 billion (+7.3 per cent QoQ). ICICI, Kotak Bank, Indusind, FB and CUBK saw a strong quarter. NIM would be the key monitorable as repo rate has been hiked by 140 bps YTD and banks with higher EBLR-linked loans and positive ALM would benefit,” the company adds.