Quality banks will grow, but can’t reclaim high valuations of the past, says S Naren

Naren said that the experience of other countries shows that whenever there were big corrections, it was because of badly managed macros.

With the non-performing assets wiped out from banks’ balancesheets and the economy looking up, most investors expect bank stocks to be front-runners in the continuing bull run, but which banks could lead the race?

Celebrated fund manager and chief investment officer of ICICI Prudential AMC S Naren feels that there is need to be very selective with banks, be it private or public sector.

Even as some of the ICICI Prudential's leading equity funds are overweight on quality banks like HDFC Bank, Naren told Moneycontrol that quality banks will not be able to reclaim the high valuations they enjoyed earlier as their large base will not allow them to maintain the growth rates of the past without taking on additional risk.

Private sector banking stocks have been underperforming for a year now. HDFC Bank is down 1 percent, Kotak Mahindra Bank is down 7 percent, ICICI Bank is up 4 percent, while Nifty 50 is up 6.8 percent in the year gone by.

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“I doubt whether they (quality banks) can go back to the valuations that they were enjoying 10 years ago, simply because many of them are much larger today.” As these banks are much larger than they were 10 years ago, it is hard to justify the high price-to-book multiple they enjoyed in the past, Naren said.

“When you're small, you can have very high price-to-book because they can they can grow at very high pace. Some of these banks were growing at 30-40 percent. It would be almost impossible to do that kind of growth going ahead.” said Naren.

He said quality banks are firmly on a secular growth story in India, which makes a case for investing in them. However, their valuations of the past may not serve as good benchmark. “Can their price to book keep going up? The answer is no. That's the challenge in some of the private banks which have now become very big.” Naren added.

Watch S Naren's full interview on Samvat 2080

As for public-sector banks, he said, across-the-board stocks have seen significant re-rating and are thus expensive. Public-sector banks will have to be evaluated individually for whether they will continue to maintain their asset-quality or fall prey to bad assets yet again.

So again, time to be selective because “There was a superb way in which they brought down their non performing loans. Due to that, they got rerated. From here, you have to look at them individually and see what happens to their net interest margin, and can they continue to maintain the very low level of non-performing loans. Some banks that declared results recently have been able to manage with almost no provisioning because the book is so pristine. Can it remain like this way, even in private sector, it won't,” said Naren.

Picking stocks when they are very cheap is easier, however, in the current markets as stocks have been re-rated substantially, it poses a challenge, he concluded.

Nifty PSU Bank index has advanced over 36 percent in the year gone by, with constituents like Bank of Baroda up 15 percent, Bank of India up 35 percent, and Canara Bank up 24 percent.

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