PSU Banks: Kotak Institutional believes valuation convergence prompts review; prefers SBI, downgrades Canara Bank, PNB

After an over 32 percent jump in the Nifty PSU Bank in 2023, brokerage house Kotak Institutional Equities believes that the valuation convergence prompts a thesis review. "The investment thesis of preferring Tier 2 PSU bank stocks has performed well in the past year or so, driven by credit cost normalization.

However, valuation multiples have now converged sharply, prompting a review of our recommendations," said the brokerage. Given the relative strength of SBI as a franchise (demonstrated over the last credit cycle), Kotak now recommends owning it over other PSU banks. It has maintained BUY on SBI and ADD on , but downgraded (ADD), (ADD) and (REDUCE).

The brokerage pointed out that the asset quality for PSU banks has seen a steady recovery in the past few years toward the end of the corporate NPA cycle and even held up well through the COVID 19 pandemic – contrary to the expectations of many. "This recovery cycle began with a declining trend in slippages, which was followed by declining GNPA ratios.

We have now seen credit costs also decline as net NPA ratios for most PSU banks have converged to a level of about 1.0 percent. The steady decline in credit cost has driven a steady improvement in RoE closer to mid teen levels," noted Kotak. With increasing comfort in the outlook for asset quality and return ratios, the Tier 2 PSU bank stocks saw a sharp rally recently and their valuation multiples have now converged closer to those of SBI, which traded at a valuation premium for a few years.

As a consequence, the investment thesis of favoring these inexpensive stocks has played out very well, it added. Stock returns In the last 1 year, all Nifty PSU Bank constituents have given positive returns with PNB surging the most, up almost 67 percent, followed by , which rose 62 percent. Union Bank of India, , , , Canara Bank, Punjab & Sind Bank and have also jumped between 30 and 51 percent in the last 1 year.

Bank of Baroda and Bank of India also added over 20 percent each. Meanwhile, SBI is the worst performing PSU bank in this period, up just a little over 3 percent. With the recent swift convergence in valuation multiples, the brokerage has reviewed its investment thesis on the PSU banking space. While earlier, it favored holding Tier 2 PSU bank stocks, given the anticipated asset quality recovery; making an investment case for them now is challenging unless the brokerage believes that Tier 2 banks would be able to deliver superior return ratios for a much longer period, led by a healthy differential in loan growth, superior revenue mix leading to better operating profit ratios and importantly lower credit costs.

"We do not think we have any evidence to change this thesis. SBI, in our view, has demonstrated that its franchise has been better than other PSU banks peers in terms of through the cycle credit cost, liability franchise, asset franchise as well as digital/technological enhancements. Hence, we prefer to now go back to recommending SBI over the other PSU banks," it explained.

Livemint tops charts as the fastest growing news website in the world to know more. Unlock a world of Benefits! From insightful newsletters to real time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away!.