Market rout: Financial sector stocks are not attractive yet, say analysts

Marque stocks are available at significantly lower valuations, but near-term risks may not be fully priced in

The recent meltdown in valuations of some of the top names in the financial sector — such as the HDFC twins (HDFC Limited and HDFC Bank), Bajaj Finance, ICICI Bank, Axis Bank and State Bank of India (SBI) — has rekindled investor interest in the banking and financial services space. As most of these stocks now trade closer to their 2008 levels, when the world was hit by the global financial crisis, there seems to be a consensus among brokerages that they have become attractive. But, if investors look deeper, beyond valuations, multiple concerns cloud over these stocks. Analysts say despite the recent dispensation on asset quality provided by the Reserve Bank of India (RBI), it may not have fully addressed the pain points yet.

Growth may fall further

While much has been talked about how growth has been on the slow mode for long, this aspect becomes critical in the context of a nationwide lockdown. Analysts at JPMorgan warn that the COVID-19 dislocation could last until June/July, but the impact on the real economy will likely last longer. 

“The dislocation in the economic output in the near term will be sharp — that’s a likely scenario. However, the second-order impact of this slowdown, on medium-term growth, is uncertain at this point and the resultant stress in the economy, as the problem recedes, could be long-lasting,” they caution. This view is also subscribed by analysts at PhillipCapital, who note that banks are most vulnerable to a new leg of asset-quality crisis. “The most uncertain part is the lockdown period and the time the economy would take to return to normalcy,” they add.

Banking stocks globally are viewed as a proxy of a country’s growth rate and with India having lately become a consumption-led economy, this logic holds good even for Indian banking stocks. “Low growth may become a new normal for India and banking stocks going forward,” says Abhinesh Vijayraj of Spark Capital. Whether HDFC Bank or RBL Bank, or SBI, analysts at JPMorgan have slashed their loan growth estimate by 6–17 per cent, FY21 earnings estimate by 2–79 per cent and believe that banking stocks in their coverage could at best grow by 1–14 per cent in FY21. This also is the first time since 2010 that banking stocks across the board are being subjected to a sharp downgrade in earnings estimates and target prices, which should be a good indicator for investors to appreciate that multi-year low valuations may itself not be a reason to turn optimistic on the banking sector.

Multiple asset quality threats

After Friday’s relaxation from the RBI on asset classification, analysts widely agree that it could bring some near-term respite to the asset quality of banks. But, they also feel the move could more be a deferment of pain and not exactly a measure to alleviate it. 

“We expect supply chain stress to manifest itself via higher slippages in the mid-corporate space, which, in turn, will imply higher downgrades in the BBB and BB loan book and higher non-performing assets (NPA) numbers,” say analysts at JPMorgan. They say the stress is increasingly becoming sector agnostic and will likely not be specific to any industry, though real estate and hospitality look exceptionally vulnerable at this point. 

These concerns are in addition to stress, which was already building in segments, such as small and medium enterprises (SMEs), unsecured retail loans, microfinance, and telecom. Analysts at ICICI Securities point out that unlike the December quarter when banks had huge sums of money flowing through the Essar Steel resolution, there aren’t any large cases of resolution available for banks in the near term which could further increase the NPA numbers. 

Consequently, analysts at PhillipCapital have identified that the potential stress as a ratio of total loan book could be 4.3–8.4 for top banks, such as HDFC Bank, SBI, ICICI Bank, Axis Bank and IndusInd Bank, should the worst case of asset quality (all points mentioned above turn against banks) play out.

For these reasons, even if investors must look into the stocks, which have suffered a deep correction in the last month, the available pool of attractive ones is now restricted to top lenders, such as ICICI Bank, HDFC Bank, and Bajaj Finance. That said, analysts at ICICI Securities warn that it is not necessary for the leaders of the previous rally to remain so in a new rally. “Outperformers may change ahead,” they say.