»5 Minute Wrap Up by Equitymaster

On This Day - 14 NOVEMBER 2018
A Corporate Bank Stock With 80% Upside

Sarvajeet Bodas, Research analyst, The 5 Minute Wrapup

  • "You hear about how many fourth quarter comebacks that a guy has and I think it means a guy screwed up in the first three-quarters." - Peyton Manning, record-breaking NFL quarterback

This quote comes from American Football. It means a player who has performed poorly for three quarters of the game, has made a grand comeback in the final quarter.

He receives well-deserved praise for his late effort but it doesn't hide the fact the he did not play well throughout the game.

It reminds me of the current situation of India's corporate banks. These are banks with significant exposure to corporate and commercial loans.

I believe, corporate banks are about to make a grand fourth-quarter comeback.

But before that, it is important to understand how these banks screwed up in the first-three quarters.

It didn't happen overnight.

The origins of their problems can be traced to 2006-08. Economic growth was strong back then. This is the time when India achieved its best GDP growth rate. The infrastructure, real estate, power sectors were enjoying their best times.

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Corporate banks got carried away. They extrapolated growth assumptions. Due-diligence and risk management took a backseat during this period.

Then the global recession happened in 2008. There was a slowdown in India as well. With this, their growth assumptions went for a toss.

This was followed by the 'policy paralysis' period of 2011-13. This created uncertainty which marred the business climate. Confusion over policies regarding mining, power, and infrastructure led to a huge backlog of delayed approvals.

All this created problems for companies who had taken loans from corporate banks. It became increasingly difficult for them to pay the interest and principal.

This is how bad loans or NPAs infected India's corporate banks.

All this had a bearing on their stock prices as well.

Compared to retail-focused banks, which did not face any major NPA issues, corporate banks considerably underperformed. More on this in today's chart below.

But they are about to make a grand comeback.

First, these big corporate banks have a strong liability franchise. It means they have access to low-cost deposits in the form of CASA (current account saving account).

After the IF&FS saga, the market is facing a liquidity crunch. During such times, having access to low cost-deposits is a blessing for these banks.

Second, the September quarter results showed an improvement in their asset quality. In other words, these banks are now fully focused on loan recoveries. Not to mention, they already have a high level of provisioning.

Also, reforms such as the Insolvency and Bankruptcy Code (IBC) would be a game changer in the coming months. The IBC will not only help them recover bad loans to an extent but also help bring back credit growth.

Finally, the changes in the management. Many of these corporate banks have seen management changes recently. In banking, a strong management team at the helm is a key differentiator when it comes to vision, focus, risk management, innovation etc. This will bring stability at the top levels of these banks.

So, is this the right time to consider buying stocks of corporate banks?

Certainly, yes.

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In addition to all of the above, the valuations of these banks are attractive now. The stocks of corporate banks trade at a significant discount to retail-focused banks.

In Smart Money Secrets, we recommended a corporate bank back in April 2018.

It ticks all the boxes I've just mentioned.

Its liability franchise is growing steadily.

Its asset profile is slowly improving with the current provisioning at its peak.

The bank has seen a complete management overhaul. The new management has already shown its laser-sharp focus on implementing changes such as risk-based pricing, an improved digital platform etc.

Lastly, the valuations. At the current price, the stock is trading near its book value. This is 30% below its historical average of 1.4x over the last 15 years.

From the current price, we believe the stock has an upside of about 80%.

The fourth quarter is here!

And corporate banks are all set to make a comeback.

Chart of the Day

Corporate banks have underperformed retail-focused banks in the last five years. The chart below shows the annualised returns of the last five years.

Corporate Banks Underperforming Retail-focused Banks

Retail-focused banks such as HDFC Bank and Kotak Mahindra bank performed significantly better compared to corporate banks. One of the important reasons for this outperformance is stable asset quality. They could maintain gross NPAs below 1% in the previous five years.

Whereas corporate focused banks such as ICICI Bank, Axis Bank, and SBI are facing serious asset quality issues. Not to mention, some of these banks had management issues as well. No wonder these banks not only underperformed retail-focused banks, but also the BSE Bank index as well.

But as I mentioned earlier, the worst is behind them.

We recommended a corporate bank in Smart Money Secrets.

Its aggressive clean-up of its corporate loan book, hiring the right people at the top, adoption of digital technology, and using algorithms in its core operations, bodes well for the bank and its stock. Smart Money Subscribers can access the report here.

If you do not have access to Smart Money Secrets, you can sign up here...

Sarvajeet Bodas
Sarvajeet Bodas
Research Analyst, Smart Money Secrets

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