Should you buy PSU bank stocks?

Most public sector banking (PSBs) stocks rallied on Friday with the CNX PSU Bank index gaining nearly 5% as compared to 1.3% change in the CNX Nifty, after the government decided to infuse Rs 70,000 crore in these PSBs over the next four years.

The first tranche of Rs 10,000 crore will be provided to lenders that need more capital and are financially weak. State Bank of India (SBI), Bank of Baroda (BoB), Bank of India (BoI), Punjab National Bank (PNB), Canara Bank and IDBI Bank will be provided capital in the second tranche, while the third tranche will be provided to banks based on their performance during the last three quarters of FY16.

Among individual stocks, Union Bank of India (UBI) ended nearly 7% higher at Rs 175 levels on Friday on the National Stock Exchange (NSE), while BoB, IDBI Bank, SBI, Canara Bank, Allahabad Bank, Bank of India and Indian Overseas Bank gained around 4% - 6.5%. PNB, however, closed 0.8% weak at Rs 150 levels.

Investment strategy

Given the development, should you invest in stocks these banks? While the move to recapitalise is in the right direction, analysts say, there is still no visibility of earnings improvement.

Explains Vaibhav Agrawal, vice-president (research - banking) at Angel Broking: "These banks needed capital and this move by the government is a step in the right direction. But one must also understand that the banks need this money to cover for their non-performing assets (NPAs) - existing and what could come up over the next two - three quarters. Thus the problems are not yet over and this capital would be required to clean up their books."

"There is still no visibility that the banks will be able to return to a situation where they can give, say 15% return on equity (RoE). That apart, they'll still not be fully capitalised as well. Investors should look to buy a profitable entity. Just because an entity is not making money but is trading at a cheap valuation does not generate a very strong fundamental reason to buy the stock. Recapitalisation is an incremental step, but a lot more needs to happen before they become convincing fundamental buys," he adds.

A recent report by UBS suggested Punjab National Bank (PNB) to have a relatively higher share of loan approvals to potentially stressed companies (as a percentage of loans) among the PSBs. According to the report, the percentage of immoveable property - backed loans for SBI stood at 35%, for PNB at 36% and BoB at 43%.

Government capital allocation begets growth strategy reset at the banks, point out Nilanjan Karfa and Anurag Mantry of Jefferies, who will need to closely track which loan segments they need to cater, based on their core competence, capital usage (risk weights) and risk profile of customers, among others, to improve on the profitability ratios (RoA/RoE) while at the same time conserve as much capital as possible.

Dhananjay Sinha, Head of Research, Economist & Strategist, Emkay Global Financial Services sees little scope for significant valuation upsides in banking stocks. "Slower-than-past business growth, limited scope for margin expansion and the likelihood of restructured loans defaulting could keep valuations modest. Additionally, the slowdown in the rural segment could lead to rising defaults/ loan waiver demand in agricultural loans, to which PSU banks remain vulnerable. We remain cautious on all public sector banks," he said in a recent report.

G.Chokkalingam, Founder & Managing Director, Equinomics Research & Advisory, however, suggests that it is an appropriate time to accumulate these stocks. "Firstly, the NPA cycle is peaking out for many of them. Secondly, the interest rate cycle is headed towards further significant downward correction. One should pick up PSU banking stocks which have net NPA below 2.5%, stong double digit credit growth and also available at 10% to 20% discount to adjusted book value," he says.