Three Best PSU Bank Stocks To Buy Now: IIFL Research Report

PSU Banks – Re-rating on cards

PSU Banks are likely to see turnaround in profitability given that most of the pain has been recognized and NPA & credit costs are peaking out, which will lead to an improvement in return ratios. With an anticipated improvement in the capex cycle over the coming years, PSU Banks are likely to benefit the most since they hold the majority market share in the lending book (68% as of Q4FY19). PSU Banks have also strengthened their balance sheet by improving their provision coverage ratio, reduction in stressed assets and capitalization from government.

We believe PSU Banks are likely to report better earnings going ahead driven by moderation in slippages leading to lower credit costs, improving margins through better income recognition and improving loan growth. We believe SBI, Bank of Baroda and Canara Bank will lead the rally in PSU Banks.

SBI: SBI has multiple levers to improve its RoA viz. improving domestic loan book growth, lowering stress asset formation, decline in slippages & credit cost and improvement in return ratios. Further, low cost deposit profile and better income recognition will drive NIM. The stock is trading attractively at 1.1x FY21E P/BV.

Bank of Baroda (BoB): BoB to benefit from merger synergies, lowering stress asset formation, decline in slippages & credit cost and improvement in return ratios. The stock is trading attractively at 0.60x FY21E P/BV.

Canara Bank: The bank’s improving asset quality, better NIM prospects and rising non-interest income bodes well for its profitability over FY19-21E. The stock is trading attractively at 0.59x FY21E P/BV.

From the technical perspective, SBI has confirmed a multi-year consolidation breakout, indicating meaningful upside in the medium term. Bank of Baroda has exploded out from the long drawn Symmetrical Triangle pattern, which signifies that an upmove is likely. Canara Bank has witnessed a Golden Crossover, which indicates that the trend has reversed and is all set to move higher.

Improving asset quality of PSU Banks to aid faster RoA expansion PSU Banks, which have been suffering from rising bad loans, are witnessing moderation in their GNPA & NNPA ratios as well as slippages and credit costs since the last few quarters. Their stressed asset formation has also considerably reduced. We estimate that the GNPA ratio of PSU Banks are likely to decline from 9.2% (expected) in FY19 to 7.5% in FY21E. We expect credit costs for PSU Banks to continue normalization over FY19-21E leading to faster RoA/RoE expansion.

Further, strong balance sheet will support their profitability over FY19-21E. Considering these favorable factors, PSU Banks are poised to perform better in terms of profitability and return ratios. Asset quality of PSU Banks to improve

PSU Banks have higher deposit market share vs. Private Banks

PSU Banks have ~74% share in the total deposit base as against ~26% for private sector banks for Q4FY19. Notably, deposit growth of Private Banks has picked up, but lag on the loan growth front continues as they have higher loan/deposit ratio as compared to PSU Banks. As a result, frontline Private Banks are either increasing Term Deposit (TD) rates to accelerate deposit accretion or are utilizing market borrowings to fund credit growth.

Contrary to this PSU Banks’ credit growth is mostly funded by deposits. Better deposit franchise for PSU Banks vis-à-vis Private Banks will provide them competitive advantage over private peers in terms of falling cost of funds and margin improvement. Moreover, it will also aid consistency in liability profile for business growth.

Attractive valuations make select PSU Banks compelling Buy

The earnings trajectory of PSU Banks is likely to trend up over the next few years. Lower incremental stressed asset formation, higher resolution of stressed assets, improved growth appetite and enhanced revenue recognition will drive the profitability of these banks. Since PSU Banks are trading at attractive valuations of >1x FY21E P/BV (barring SBI), we believe there is a strong case for re-rating going forward given improving earnings growth prospects.

Multi-year consolidation breakout

The stock has been oscillating in a controlled range of `150-330 for the past nine years. Since October 2017, SBI made multiple attempts to breakout above the trading range but failed to do so.

However, for the first time the stock has successfully managed to surpass the rising trend line resistance which was placed at `325. This breach has confirmed the multi-year consolidation breakout indicating meaningful upside in the medium term.

Higher top higher bottom structure

Our larger time frame analysis suggests that since hitting the June 2006 lows of `56, SBI has persistently recorded higher tops and higher lows on the charts. Stock has also held convincingly above its long term 200-DMA and is also riding the Golden Crossover wave at the current juncture.