Banks & Financial Services - Earnings preview for quarter ended December 2011 - BRICS Research

We expect banks to report relatively weak operating trends as topline growth was likely challenging and credit costs headed higher. Our expectation for NII is predicated upon a slowing loan growth coupled with lower NIM yoy (except SBI). That said, NIM should stabilize sequentially and likely to improve going forward as funding costs decline, in part as policy rates ease in the coming months although banks with higher dependence on NRE may see incremental pressure. Our outlook for loan growth for the sector is in the 16-18% range for FY12 although we expect some of the private banks such as KMB and HDFCB to grow significantly faster. While asset quality and fresh slippages are likely to deteriorate given weakness in operating environment, the extent of weakness and outlook would be key drivers of stock performance.

Non-interest income was challenging across the sector, particularly non-bank fee income from capital markets, securities brokerage and asset management. Life insurance is reviving with October-November APE up 10.8% yoy. We see moderately lower expense growth given increasingly challenging revenue growth environment. We estimate that Axis, HDFCB and IIB have a larger proportion of discretionary costs in the expense base and greater opportunities to cut costs. That said, IIB is in an investment phase, it may be less inclined to cut expenses significantly.

Our EPS estimates and price targets are headed lower. Price target are impacted by lower earnigs and lower valuation multiples given challenging operating environment.

Near-term sector outlook cautious. While operating fundamentals may take at least 2-3 quarters to improve, current valuations are pricing-in extreme pessimism. For longer-term investors, we believe the potential upside far outweighs downside risks. We recommend they selectively add positions in banks with strong topline and good management track record. Maintain Buy on SBI, HDFC Bank, PNB, BOB and Axis Bank and add ICICI Bank to the list. Upgrade KMB to Add from Reduce given upside to our price target.

Banking stocks have been beaten up on concerns related to asset quality, and with earnings season around the corner, should reported results indicate that asset quality is holding up slightly better than expectation, it could be a catalyst for the stocks. Also, we expect bank stocks to react positively if there is meaningful government action on the policy front.

Upgrade ICICI Bank to Buy from Add: We upgrade ICICI Bank to BUY given sharp correction over the last two months. While the bank may not escape asset-quality issues should the banking sector face an event shock from the infrastructure sector, we believe bulk of the assets are likely to be restructured with lower impact on profitability. To that extent, on peer comparison, current valuations are cheap.

We expect a dull FY12, although FY13 could prove marginally better as the bank recovers margins on its domestic book owing to loss-making securitisation book running off. In addition, some more margin will accrue from its international book as higher-cost funding taken in 2007 gets replaced by much cheaper financing options. Asset quality will remain a key monitorable given higher exposure to infrastructure (funded and non-funded).

Upgrade KMB to Add from Reduce: We upgrade the stock to Add given moderate upside to our price target. Despite a challenging operating environment, its solid asset quality has supported the stock. KMB’s fundamental outlook remains strong and we expect it to outshine peers in terms of asset quality because of its lower credit costs and slippages. Loan growth should also be well above the industry average although NIMs should continue to decline, partly because of the changing asset mix but also as funding costs continue to rise. In the current environment, we expect banks with a predominantly retail loan book, such as KMB, to show lower delinquencies.

Also, with a tier-1 capital ratio of close to 16%, the bank is well positioned to absorb significant shocks should the economic environment deteriorate significantly. That said, given its excess capital, we believe the bank should trade at a valuation discount to historical levels. While we like the fundamentals of the bank, the stock is fairly valued trading at 2.4x price to forward book (vs. 2-year average of 2.7x). Also, given the ongoing slowdown in the capital markets, asset management, and brokerage industries, contribution from these is not likely to show traction anytime soon.

Source : Equity Bulls

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