Why Madhu Kela, Vikas Khemani and N Jayakumar are bullish on PSU banks

In Q2FY24, a majority of PSU banks have seen an increase in profits and decline in NPA numbers.

The stupendous rally in PSU banks may be far from over, even as stocks in this pack have been multi-baggers over the past two years, according to ace investor Madhusudan Kela, Carnelian Assets' Vikas Khemani and N Jayakumar of Prime Securities.

The three investors were commenting on the performance of banking stocks over the past year during the Diwali Party show at Moneycontrol on November 12.  According to Khemani, the main trigger for this pack stems from three things: transformation across asset quality, better governance and technology.

PSU banks were among the major gainers, and rose over 2.6 percent during trading hours during Muhurat trading on November 12. The Nifty PSU Bank index has gained over 38 percent over the past year, and 77 percent in the last five years. As of November 13, the index was at 5,178.

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What has changed

At one point, the asset quality and governance of PSU banks were worse than private lenders, and they had poor technology – losing out to most private sector banks. But this has changed over the last 4-5 years. According to Khemani, the PSU banking sector now boasts of good asset quality and is functioning with minimal interference from the government.

In Q2FY24, a majority of PSU banks have seen an increase in profits and decline in NPA numbers. For example, the Gross Non-Performing Asset (GNPA) ratio of Canara Bank fell to 4.76 percent from 6.37 percent year on year (YoY).

Even the net non-performing asset (NNPA) ratio fell to 1.41 percent, down from 2.19 percent in the same quarter last year.

Ace investor Madhusudan Kela cited the example of Canara Bank to show why he believes in investing in PSU banks. The PSU lender has made a profit of Rs 7,000 crore in the first half of 2023-24, and its guidance is to repeat the same performance in the second half.

“That is around Rs 15,000 crore profit and a market cap of Rs 75,000-80,000 crore,” he said.

Also read: PSU bank stocks beat private peers in one-year returns, keep brokerages upbeat

At 5x PE, the valuation is not expensive and is less than 1x book value. “It’s just a case of sour grapes for those who didn’t invest. They have to find a reason for consolation- of waiting, consolidating and waiting again. But this is not a game for those who stop,” he said.

In the last quarter, while many private sector banks have given virtually zero return in the timeframe, some of these public sector banks have given 400 percent, 500 percent and 600 percent returns.

“But this is true only for a short period of time – you have to buy them cheap and then sell them cheap,” Kela said.

‘Investments in technology have helped’

Investments in technology have also helped in giving PSU banks an advantage. Khemani said that, earlier, private banks had the advantage of technology. But now, with large investments, PSU banks have gotten their technology right.

“Today, technology is no more innovation, it is plug and play. So they can deliver the same or maybe sometimes better service than a private sector bank,” Khemani added.

On improvement of governance, Kela says: “Do a dipstick check with the 10 PSU chairmen. You go and speak to them and ask them, in the last five years, how many calls did they get from Delhi for a loan? You will get the answer.”

N Jayakumar of Prime Securities highlighted the valuation gap between private and PSU banks. While private banks are quoting up to 3x book value, certain PSU banks are struggling to come up to even 1x book, 'because the gains are difficult to digest'.

Besides, investors have to consider this valuation gap in the context of the fact that today the business mix for public sector banks is as much retail-focused (where bad loans tend to be low) as that of private banks, and project financing (where chances of bad loans are high) has reduced dramatically and provisions have been made already.

This gives rise to the question why private banks should trade at a premium valuation like 2-3x book value, and public sector banks struggle to come up to 1x book value.

Thus, while there could be consolidation in the sector, looking at the big picture, since the index weightage to banks stands at 42 percent, which is fairly high, a redistribution of capital within the sector is not only likely but underway.

Earlier, when the asset quality was bad, one used to do adjusted book value and when the bank had book value, one would adjust downwards.

“A chairman told me that he had a gold mine of Rs 1 lakh crore that is outside of the book value that he has written off. So, if you were doing adjusted book value downwards, why not upwards? If you consider that, PSU banks are available at 0.5, 0.6 book value but, currently, the market is not giving any value,” he explains.

Most of the PSU banks are now at 17-18 percent ROE, which many private sector banks have not been able to achieve. Khemani said that, ultimately, those who believe in the sector and the transformations that are taking place will make money while others will lose out.

Khemani also quoted a bank chairman asking why bank valuations should not be looked at based on adjusted-book value at a time they may be witnessing write-backs.

Potential write-backs in the coming years will mean higher adjusted book value estimates, making current valuation look cheaper. As analysts estimate lower adjusted book value after considering future provisioning estimates, banks trade at lower valuations. As the reverse is likely to happen, bank stocks should be looked favourably, considering forward estimates, experts argued.

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