PSU bank stocks at all-time high as quality banks face setbacks. Will the rally continue?

The Nifty PSU Bank index has rallied 81 percent in the last one year. Much of the rally was to do with improving fundamentals of PSU banks.

Nifty PSU Bank index touched an all-time high on April 26. After constant interventions by the regulator on private banks and NBFCs, experts feel that public sector banks (PSUs) could be a better way to play the banking theme. Among the very recent ones is Kotak Mahindra Bank, where the central bank asked the bank to stop onboarding new customers through online and mobile banking channels.

Also read: MC Explains: Why investors are more excited about PSU banks than private sector lenders

The Nifty PSU Bank index touched an all-time high of 7,470.65 on April 26. In the same lot, SBI touched an all-time high of Rs 816, while Canara Bank touched an all-time high of Rs 624 on the same day.

High demand for capital for infrastructure, which will result in strong credit growth, and improving return on equity (ROE), and the inclusion of Indian bonds in the global bond index, are expected to make the case for PSU banks stronger.

"There is a lot of demand for capital for government infrastructure right now, and the majority of this demand will be captured by public sector banks," said Vikas Gupta, chief investment strategist at Omniscience Capital. He also said that Return on Equity (ROE) for PSU banks is expected to go up significantly. Currently, ROE for private banks is at a decent level, limiting further upside. PSUs have scope to improve further.

Besides, India's inclusion in JP Morgan’s Emerging Markets Bond Index will result in an uptick in bond prices that could help PSU banks boost treasury income, said Neeraj Gaurh, fund manager at Axis Securities. He, however, said it will not lead to a significant improvement in income. "What will, however, also help is that after India's inclusion in the global bond index, PSU banks could get global visibility, which will enable them to attract significant capital at a lower rate," said Prasanna Bidkar of Rupeeting PMS.

Another aspect that is helping PSU banks, Bidkar said, is that they have become stringent in their loan recovery process, just like other private banks. He said that most of the PSU banks have started following up regularly for loan recovery. This will help them keep books cleaner and minimize NPAs.

On valuations

Yet, experts say that most of the positives for PSU banks are already reflected in their valuations.

Compared to historical averages, PSU banks are beginning to look expensive. Traditionally, PSU books used to quote at less than one time (stock) price to book value. Most of them are now quoting at more than one time the book value.

Even so, compared to other sectors, banks are among the most undervalued sectors. In a previous conversation with Moneycontrol, ace investor Madhusudan Kela had said, "The market has been saying that public sector banks are overvalued. Actually, but a lot of public sector companies are trading at over 30-40 P/E while public sector banks are still trading at single-digit P/E if a two-year forward view is taken." Besides, the absence of near-term triggers for private sector banks to perform because of the heightened regulatory vigil, is a big factor in support of public sector banks.

Strong Rally

The Nifty PSU Bank index has rallied 81 percent in the last one year. Much of the rally was to do with improving fundamentals of PSU banks. Till a couple of years ago, PSU banks had a lot of bad loans on their books because of which they were unable to make new loans. This meant that they kept losing market share to private banks. PSU banks have now written off most of their bad loans, and their asset quality is much better.

Gaurh said, "The improvement in fundamentals has driven the stock prices higher for PSU banks in the past one year, which means, it will make it be difficult for them to outperform Nifty 50 in the coming quarters.” But in view of the favorable factors supporting their growth story, any short-term volatility will be an opportunity to re-enter PSU banks," said Bidkar.

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