What if you had invested in the stocks of India’s best banks, but a few years later realised that their FDs would have given better returns instead?
Or, whatever extra returns the stocks gave weren’t worth the volatility and the risk?
That’s the tale of investors who had five years back bet on stocks like Kotak Mahindra Bank, HDFC Bank and IndusInd all of which were prized for their low NPA ratios and high ROEs (return on equity).
Their stellar 5-year stock returns CAGR (as of November 2019) amidst the turmoil in the broader banking industry gave investors more confidence that the outperformance was set to last. But the reality turned out to be different.
The average stock price CAGR of the cleanest three banks (read, low NPAs) in the last 5 years (Nov 28, 2019-Nov 28, 2024) is just 0.1 per cent.
This is also reflected in the Nifty Private Bank index CAGR at just 7.4 per cent compared to a robust 20.3 per cent CAGR of the Nifty PSU Bank Index. Why so and what lies ahead?
Valuation matters
While the three banks did maintain their solid performance going by core metrics like NPA and RoE, the tables turned due to two reasons — peers fixing the weak points in their businesses and investors warming up to opportunities they offered.
In the process, the valuation premium of HDFC, Kotak and IndusInd banks — which were amongst the highest in the industry — has shrunk in the last five years.
Besides, PSU banks have undergone a clean-up and now boast of good quality loan books. Note that the period analysed here also includes the pandemic years when asset quality was under pressure.
Today, the gross NPA ratios of banks such as SBI and Bank of Baroda are quite close to their private sector counterparts. The net NPA ratios of SBI, PNB and Bank of Baroda (BoB) at 0.5, 0.5 and 0.6 per cent, respectively, are quite comparable with private lenders that have net NPA ratios of around 0.4 per cent.
The RoE of PSU banks having withstood the balance-sheet clean-ups have massively improved, even surpassing FY14 levels.
These factors have resulted in a re-rating of PSU banks.
The PSU Bank Index now trades at a P/B multiple of 1.3 times, a premium to its 10-year average of 0.97 times.
ICICI and Axis, too, saw improvement in the RoE, post a management change. However, the same cannot be said about HDFC Bank, IndusInd Bank and Kotak Mahindra Bank.
The fact that these stocks are now facing competition from attractively valued PSU banks in terms of competent RoE with comparable net NPA ratios, makes their valuation premium fade.
Their premium valuations owing to their superior asset quality in the five years prior till November 2019 have significantly de-rated.
What’s ahead?
In the latest quarter ended September 2024, Kotak Mahindra Bank, IndusInd Bank and Axis Bank reported stress in their unsecured portfolios, specifically credit cards and microfinance. While HDFC Bank’s asset quality has remained pristine as always, it is facing post-merger difficulties — lower Net Interest Margin due to HDFC Ltd’s high-cost borrowings and constraints on loan growth due to a high credit-deposit ratio.
ICICI Bank, however, is better placed with no such woes and thus has bucked the trend.
Though the PSU Bank Index now trades at a premium to its 10-year average, it is still at a discount to its recent peak of about 1.9 times in June.
The fact that risk-averse investors now have quality options outside the private banking space cannot be denied.
However, with the time-wise correction that has played out in stocks like HDFC and Kotak bank, investors can warm-up to potential opportunities they may offer for the long-term.
