BofA, CLSA think Axis, IndusInd Bank are ripe for re-rating; here's why

Shares of Axis Bank and IndusInd Bank Bank have, so far, outperformed the benchmark S&P BSE Sensex in calendar year 2021, on the back of consistent foreign capital inflow and hopes of sustainable economic recovery.

Till Thursday, January 7, shares of Axis Bank have rallied 8 per cent while those of IndusInd Bank have jumped 6 per cent on the BSE. In comparison, the S&P BSE Sensex is up 0.72 per cent, ACE Equity data show.And this outperformance is likely to continue.

Analysts at BofA Securities have "turned positive" on the Indian banking sector, and have upgraded Axis Bank, IndusInd Bank, and State Bank of India (SBI) on a "surprisingly" resilient asset quality outlook, and reasonable valuations.

"While we acknowledge stretched tactical in the near-term, and potential for some volatility in first half of calendar year 2021 (H1CY21) as the NPA recognition cycle begins, we see risk-reward attractive on a 1-year perspective as growth will likely surprise positively for the bigger banks in H2CY21," it said in a report dated January 5.

Those at CLSA, meanwhile, remain optimistic on the sector on expectation of benign credit cycle for retail and corporate sector. It sees further legs for re-rating in ICICI Bank, SBI, and Axis Bank.

Here’re the five reasons for their optimistic outlook:

Asset quality: BofA opines that the actual asset quality concerns in calendar year 2020 turned out to be "much more limited than worried". The reason, they say, could be the banks’ already risk-averse approach over the couple of years leading into Covid-19 pandemic. Investors can now expect the focus to gradually shift from asset quality to growth in 2021, it said.

That said, the Supreme Court’s verdict in the loan moratorium/interest-on-interest case continues to act as a key overhang on the sector. Subject to the SC lifting restrictions on NPA recognitions, the brokerage says banks may see an increase in new NPA formation over 3Q and 4Q of FY21.

"However, the recent capital raises have significantly boosted banks’ ability to absorb any further negative shocks arising from Covid-19. This provides both, management and investors, the opportunity to focus more on medium-term growth opportunities," it added.

Focus on growth: As the pandemic-battered economy recovers from the Covid-19 blows, Bank of America analysts, note that banks have gradually come out of their ‘risk aversion’ mode. With all the factors now in places for a broader recovery in credit demand – lower real interest rates, abundant liquidity, better-than-expected improvements in macro indicators, and a sustained investment push by the government, banks are seen deploying capital and return to new normal growth.

Regulatory support: The Reserve Bank of India (RBI) has infused abundant liquidity in the system, acting as a major tailwind for the sector. While bigger banks used the opportunity to significantly cut their funding costs (resulting in NIM improvements), mid-size and smaller banks offered slightly higher deposit rates in an effort to further ‘retailize’ their deposit base.

"In the near term, net interest margins (NIMs) appear to have stabilized but the RBI policy direction adds a bit of uncertainty over the next few quarters. Our economists expect another 50 bp rate cuts in February 2021," noted BofA in its report. Retail savings and fixed deposit rates are already close to historic lows, leaving banks with little room to pass on further rate cuts. "But if lower rates could help a recovery in growth, the net impact could be minimal," the report observed.

Earnings: BofA Securities have revised their EPS estimates for FY21-23E on the back of more optimistic macro growth, and asset quality assumptions. Bank of Baroda, from the PSB space, and ICICI Bank, from the private sector space, are the biggest beneficiary of the upgrade with 58 per cent and 9 per cent, respective upward revision in EPS of FY22 from FY21.

CLSA, on the other hand, expects mid-teen growth in large private banks’ operating profit.

Valuation: Despite the significant rebound from their March lows, majority of banks are still trading meaningfully below their pre-Covid highs. S&P BSE BANKEX is up 80 per cent from March lows but has lagged the market by 18 per cent in 2020.

"The recent massive outperformance and relative valuation premiums recovering near-term sustain outperformance might see some pressure. But as growth recovers over a 12 month period, the risk-reward has turned more attractive in our view," the report said.

BofA sees nearly 26 per cent and 28 per cent upside in Axis Bank and IndusInd Bank from current market price and has a target price of Rs 780 and Rs 1,150, respectively and have upgraded the stocks from ‘Neutral’ to ‘Buy’. Besides, it sees an upside of 21 per cent in ICICI Bank (TP: Rs 650); 18 per cent in HDFC Bank (TP: Rs 1,700); 12 per cent in SBI (TP: Rs 276), and 5 per cent in Bank of Baroda (TP: Rs 62).

CLSA has revised target price of ICICI Bank from Rs 625 to Rs 675; of SBI from Rs 360 to Rs 385; HDFC Bank from Rs 1,700 to Rs 1,725; and IndusInd Bank from Rs 710 to Rs 1,025.