Sunday, September 19, 2010

>Why SOE Banks Remain Top Picks Among Asian Banks

Despite their run-up, we think Indian SOE banks still offer significant upside potential: When we look at historical multiples, SOE bank stocks are trading at close to all-time highs. However, in our view, that may not necessarily be the right metric for this group. Historically, they were growing at a much slower pace than system and underlying profitability (ex bonds) was very thin. However, things have changed.

SOE banks have changed meaningfully over the last 4-5 years: The market share loss (in loans, deposits and fee income) has abated. Private banks are now growing at a few percentage points more than SOE banks, rather than the 2-3x we saw in the mid-2000s. Moreover, while bond-related revenues collapsed (from 40% of revenues in F2005 to 12% in F2010), underlying
profitability has picked up. Core business contributed only 0.4% to ROA in F2005 – it is now closer to 0.9%.

With market share loss stemmed and growth profile/underlying profitability improved – we think these stocks can trade at higher than historical multiples. We are raising our 12-month price targets very aggressively – they now imply 30-50% upside for our coverage stocks: This sounds high (especially following a 70% run-up in the last 12 months), but it implies that these stocks will still trade at 6.5-10x our estimates of forward earnings and 4-6x PPoP in 12 months. We had an OW on all SOE banks except OBC and Canara – which we are also upgrading to OW. We would buy a basket of SOE banks (in our coverage).

All Indian SOE banks combined (77% of the nation’s banking system) have market cap less than Bank Itau in Brazil (and obviously each of the big four Chinese banks). This seems unsustainable to us given the improved profitability and growth profile at SOE banks. These stocks will be volatile (bond moves, asset quality concerns), but on a structural basis, we believe that this
is the top segment within Asian banks.

To read the full report: INDIAN FINANCIAL SERVICES