PSU Banks will continue to outperform

We had recommended betting on the government-owned (PSU) banks (PSU Banks may double in two years) in the February 16th, 2016 edition. Since then, while the Sensex has moved up 19%, the BSE Bankex, a benchmark index that tracks the banking stocks, has gained 31%.

We had advised the investors to pick up the PSU banks which had relatively lower net NPAs (Non-performing assets) and also managed to grow their credit close to the industry average. Many PSU banks, which had fulfilled these two criteria at that time, have already rewarded the investors with over 50% gains within the last 5 months. Actually, post-March 2016 results, most PSU banks have pulled back over 30%.

The stringent regulatory norms on asset quality recognition forced many PSU banks to post huge losses in both December 2015 and March 2016 quarters. PSU banks had lost over 70% of their market caps by February 2016 from their peaks in June 2014. Even after recent significant gains, the market caps of PSU banks are anywhere from 40% to 60% lower than the levels that existed in June 2014. The adverse conditions have led to huge differences in the valuation of PSU banks vis-à-vis the private banks and financial services companies. For instance, the combined market cap of Shriram City Union Finance and Shriram Transport Finance stand at over Rs 40,000 crore. Surprisingly, the combined market caps of 9 PSU banks (viz. Allahabad Bank, Andhra Bank, Bank of Maharashtra, Corporation Bank, Dena Bank, Oriental Bank of Commerce, Punjab & Sind Bank, Syndicate Bank and United Bank of India) stand at less than Rs 39,000 crore. Theoretically speaking, the market caps of these two private finance companies with combined net income of around Rs 14,000 crore are enough to buyout these 9 PSU banks, which have got a combined net interest income of over Rs 50,000 crore with nearly 22,000 branches across the country.

The dichotomy in the valuation gaps is, of course, partly due to a relatively better efficiency of the private entrepreneurs. However, in the Indian equity markets, the perceptions always punish or reward much more than what the fundamentals deserve in the short-term. Substantial improvement in rainfall, robust tax collections, strong aviation traffic, a 46% year-on-year rise in plan expenditure during the first two months of current fiscal, government's capital infusion, etc, augur well for the PSU banks. Therefore, in the next one year or so, the investors can hope for another 30% to 50% return from the PSU banks, which have got relatively lower NPAs and also available at a discount or around the adjusted book values.