Nomura of Japan has initiated coverage of the Indian banks sector with a NEUTRAL view. Key drivers of bank earnings – loan growth, interest rates (bond yields) and asset quality – have turned negative in 4QFY09 and are likely to deteriorate further in FY10E. Nomura expects earnings growth of Indian banks to drop 6% in FY10 after a robust CAGR of 21% over FY05-08. While banks are faced with these challenges, there is some comfort in state-owned banks’ valuations, which are trading at below book values, and fast-growing private banks, which are trading at 1-2x FY10E P/BV.
Nomura initiates a BUY on Punjab National Bank and Axis Bank. Reduce on SBI and HDFC. Neutral on ICICi Bank, HDFC Bank, Union Bank and Bank of India.
SBI is most vulnerable to an economic slowdown, as it has grown its loans aggressively, especially over the past four quarters, and has high incremental exposure to sensitive sectors. SBI is expected to report an EPS of Rs 130 for FY10.
HDFC is among the best managed finance companies in India, with a sound management team, strong risk management practices, strong earnings growth and impressive asset quality. However, like the rest of the sector, HDFC’s earnings growth and asset quality will be affected by the economic slowdown. EPS for FY10 is expected to be Rs 87.
HDFC Bank’s profit growth to moderate to 19% over FY09-11E, from 30% in FY05-08, but it is still the strongest earnings growth compared with the other Indian banks under our coverage. EPS for FY10 is expected to be Rs 64. Price target is based on 1.8x FY10E P/BV, which is lower than its mean multiple of 3.2x in the past two years and its trough multiple of 2.2x.
A severe slowdown in the life insurance business has caused valuation multiples and consensus growth forecasts to contract sharply. Rs 36. Price target of INR295, based 0.6x FY10E P/BV for the banking business and INR135 for subsidiaries.
Bank of India:
Expect earnings to decline 27% in FY10, driven by higher credit costs, lower trading gains, lower recoveries and pressure on margins. Net profit growth of 80% and loan growth of 26% in FY05-08. Price target of INR175 based on 0.7x FY10E P/BV.
Union Bank of India:
Union Bank of India has been delivering strong operating performance over the past two years, driven by a substantial improvement in deposit mix and focus on brand building. The bank’s provisioning cover is among the highest at 93%. Price target of INR130 at 0.7x FY10E P/BV is based on a target RoE of 11%, substantially lower than the bank’s last reported RoE of 27%, due largely to high credit costs and lower leverage going ahead.
Expect flat (2%) earnings growth in FY10E and 13% in FY11E, substantially slower than the 9MFY09 growth rate of 73%, due to a moderation in loan growth to 25% over the next two years, rising credit costs and slower fees. Price target of INR400 is based on 1.1x FY10E P/BV, suggesting 42% potential upside.
The bank’s earnings is likely to decline 9% in FY10E, due to higher credit costs, declining margins and lower trading gains, and then recover 16% in FY11E. PNB has the highest proportion of low cost savings deposits at 31%. Price target of INR420 is based on 0.9x FY10E P/BV and suggests 38% potential upside.