State Bank of India (SBI) is best placed to gain in the current growth cycle. Citing improvement in the retail business and a turnaround in the corporate cycle, Morgan Stanley has revised the bank’s price target to Rs 600 per share, up from Rs 525 per share.
“SBI has built a strong retail franchise and also sustained its deposit market share. Even on digitisation, the progress has surprised, unlike peer SoE (state-owned enterprises) banks,” said Morgan Stanley in a note to clients. “As the corporate cycle turns, we expect earnings estimate upgrades and significant re-rating.”
SBI reminds the brokerage house of China Merchants Bank (a well-run bank promoted by the state), which has shown sustained improvement in its retail franchise compared to China's other public sector banks.
“Though there are significant differences between CMB and SBI, we believe SBI could show a similar re-rating trend vs. Indian SoE banks,” said Morgan Stanley.
Among all the public sector banks, SBI has caught the eye of the brokerage house. “The current cycle reminds us of the early 2000s, a period in which SoE banks outperformed significantly in the initial years — SBI looks best placed to play this theme,” said Morgan Stanley. “SBI profitability does very well as the economic cycle turns - this coupled with strong improvement in the retail franchise should drive significant upside in this cycle.”
Morgan Stanley has also upgraded two other public sector banks while remaining underweight on Canara Bank and Bank of India because of their low profitability. Given their cheap valuations, Bank of Baroda (21% upside) and Punjab National Bank (16% upside) have been upgraded. Canara Bank, on the other hand, is downgraded by 3%.
Morgan Stanley sees balance sheets of state-owned banks improving, capping the downside risk for them. But these banks face structural challenges. “For (PSU) banks, excluding SBI, we see structural challenges which will keep return ratios muted – limiting any significant re-rating potential beyond the short cyclical upswing,” it said.
The brokerage believes there could be near term upside but it prefers large private banks and SBI to play the corporate recovery cycle. Though valuations of public sector banks are cheap at 0.4-0.5 times expected FY22 book value, the upside for most of them is limited as not all of them will benefit equally from the corporate recovery cycle.
Public sector banks are also expected to continue losing loan market share to private lenders due to technology changes, strong competition and a weak internal rate of capital generation.
“More importantly, we note that incremental market share for PSU banks in overall deposits has also been weakening in recent years – driven by term deposits as well as accelerated market share loss in savings deposits in urban/semi-urban areas,” Morgan Stanley said.
Public sector banks also could feel the stress if the economic recovery is weaker than expected. "Margin of safety, which refers to the potential bad loans absorption capability, remains low for PSU banks, which also doesn’t work in their favour. This will become problematic in case the macro recovery is softer than expected," Morgan Stanley said.
Three sources could present upside risk to earnings as the macro cycle turns. Morgan Stanley lists these three as:
1) higher margins as excess liquidity decreases and rates move higher
2) lower cost to income ratio - the wage hike cycle has ended, and the rate cycle is turning, which could drive slower cost growth
3) lower credit costs, helped by moderation in corporate NPLs and lumpy recoveries.
