state bank of india: Expect 20-25% uptick in financials and 40% upside in banks in near term

The entire financial space has rebounded very sharply because of the Q3 updates. The operational updates did not show things to be as dire as the market was factoring in for the corporate banks. How are you analysing these banks?
A little bit of background before we get into corporate banks. We have this flagship product. We travel to various states and talk to various industry participants and figure out what is happening on the ground and then tie it up with top-down commentary or the management commentary on the 3Q earnings.

We have taken quite a few contrarian calls. The most recent contrarian call was when we went long on financials last year in May and June itself. This time, while on the road, we spoke to people in NCR, Mumbai, Bangalore, Chennai and Kolkata. This is probably the first time in the last five years that we have not come across even a single red flag when we spoke to people on the ground. Barring the MFI sector, most other sectors have actually spoken about positive data points and the sentiment is probably at a five-year high.

My takeaways are: 1) The capex that everyone is expecting to start has actually started. Large corporates say they have already started executing the capex plans.

2) Capacity utilisation which was at 70% in October, November has probably softened to 60% now but based on inquiries, it is expected to go back to 70% plus.

3) On asset quality, we highlighted in the first half of January that the restructured book is going to be around 100 bps and that has played through.

Going forward, segment-wise, the commentary that we heard from ground is that housing is already at pre-Covid levels. Remember, housing has a multiplier impact on the economy.

The auto sector, which has done phenomenally well, shows visibility for at least three-four months more in terms of order book. Even the commercial vehicle segment. that has not really picked up, is likely to pick up over the next quarter.

As for the MSMEs and SMEs, one of the regional heads of a lender says if he is lending to thousand plus accounts and only one account will slip because of Covid related stress. It is a similar story in personal loans. Corporate which really did not really go through stress in the pandemic, their balance sheets and leverage levels are much lower as compared to what they were say one-and-a-half, two years back.

So when you look forward from here on, there are a few things that we are factoring in. The asset quality surprise played out in the current quarter. The management commentary was pretty positive. Going forward I think a lot of people will be surprised on the growth uptick, especially given the capex uptick that is likely to come through.

When you look at the sector now, this is probably the first time in the last five-six years that all the pieces are falling in place starting with a better balance sheet of banks. Then we have a supportive RBI, the Budget is growth oriented. The government has specifically focussed on growth. Demand is coming back across sectors and more importantly from a financials perspective, despite the significant uptick in the stocks, valuations are not really one standard deviation, they are not stretched. They are not close to one standard deviation above mean which we think where they could go.

So in the near term, from the sector perspective, on an average we expect at least 20-25% uptick in financials and 40% upside in banks.

Let us shift focus and talk about the PSU pack. SBI Chairman was telling us that their entire provisioning cycle may be coming to an end. Even ’s Mallikarjuna Rao echoed huge recovery figures from and some other big accounts, How is the risk reward and the asset quality looking in this pocket now?
The budget focussed on four key parameters which have a direct impact on PSU banks. The budget focussed on ensuring enough liquidity and repairing the balance sheet. It also focussed on growth with respect to capex and most importantly on improving efficiency that is essentially privatising these PSU banks to a certain extent so that it leads to better efficiency.

The

probably has 25% market share. Given that top down is going to be so strong, GDP growth is around 10.5-11%, the first fundamental uptick would be in terms of higher recoveries which the management spoke about.

Second, if the government is able to execute the bad bank or asset reconstruction company proposal over the next 12 or 18 months, that will clean up the balance sheets. So there will be better assets and better balance sheets. There are no asset quality issues. In the whole PSU banking space, the risk reward is extremely favourable for the large PSBs.

If their balance sheets are repaired and they are able to raise capital and the digitisation picks up, it will lead to better monitoring. So if we combine all of this and if some amount of efficiency can come through, then you are looking at a good uptick in the PSU banking space as well. I am not saying it will probably happen over the next two or three months, you could probably see sideways moves but from a 12-18 months’ perspective it makes sense.

What are your thoughts on valuations in the NBFC space?
From a sector perspective, I cannot take specific names but from a sector specific perspective, housing finance companies is a trade that we have been highlighting for six months. If we look at the property cycle for last 15 years — be it 2009 or 2012-13, for the last four to six quarters on an average, we have just seen one quarter of the pent-up demand coming through. So maybe the March quarter could see some decline over December but the uptick should sustain going into 2021, at least till December quarter.

Now given that the top down is going to be so strong, bottom up is going to be so strong with respect to volume offtake coming through, I may expect housing finance companies to again go back to the higher disposable levels and wait list of two or three years back. So be it HDFC or some of the large HFCs, disbursements are at 25-30% of pre-Covid level and we expect a similar trend in terms of disbursement uptick across HFCs.