Banks may see second phase of re-rating, says Morgan Stanley

Strong balance sheets, lessening macro concerns, and improving capacity utilisation set the stage for a capex up-cycle in FY24-FY25, according to Morgan Stanley. The brokerage firm believes this could drive the second leg of re-rating at Indian banks.

“A new leg of investment up-cycle led by improving trends in capacity utilisation rates, in addition to corporate sector profitability and de-leveraged banking sector balance sheet, could foster job creation, accelerate income growth, and drive more growth opportunities even in the retail/SME segment,” analysts at the firm wrote.

They observed that structural policy measures (lower corporate tax rates, PLI schemes) and a transition to a multipolar world, with companies looking to diversify incremental production, should also help. “As macro concerns lessen with falling inflation, we expect risk appetite at banks to improve,” they wrote.

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The brokerage has raised loan growth estimates by 2 percentage points to 16% for the financial year (FY) 2024 and 3 percentage points to 17% for FY25. This, coupled with lower credit costs, drives the earnings estimate upgrades. The firm said it pencilled in a 2 percentage point upgrade in pre-provisioning profit growth and higher return on equity (RoE) assumptions.

It believes access to retail deposits could be key for delivering profitable revenue growth and expects competitive intensity in retail deposits to reach a new high in the upcoming up-cycle. Private banks in aggregate, the brokerage notes, have lagged on retail deposit market share gains, and are turning aggressive. Moreover, the liquidity coverage ratio (LCR) regulations and bank mergers would intensify competition.

“Large banks – -both private and state-owned enterprises — stand out, in our view, and appear better placed to accelerate loan growth and gain share. We raise valuation multiples to reflect improved growth and profitability outlooks over the next few years,” the analysts noted.

Among the risks, the firm has listed a weaker-than-expected external demand weighing on growth acceleration, slower than expected acceleration in deposit growth and greater than expected competitive intensity.

Over the past two years, Indian bank stocks have returned to average valuations as the economy improved. Stocks that were not pricing in the credit cost normalisation did well and drove the first leg of re-rating. This was helped by strong improvement in Indian banks’ balance sheets over the past five years despite the Covid crisis. “With this, we believe bad loan normalization is in the price for most Indian banks,” the brokerage said.