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Covid resurgence, firming rates pose interim risks

For Indian financiers, the base case scenario that was building into expectations was that return to normalcy would be soon given the better than anticipated recovery, stress settling within or lower than guided ranges, and improving credit offtake. However, resurgence of Covid, imposition of restrictions and gradual firming up of interest rates could weigh on rerating of a few stocks in the interim.

Key aspects differentiating the second wave from the first

* India is witnessing second wave of Covid though emergence of cases and restrictions/lockdowns are currently concentrated in specific geographies.

* Key difference is the availability of vaccines and improved ‘injection to infection’ ratio, which can help curb the spread. Rate of mortality from the muted variant too is relatively low.

* Proactiveness, resilience and agility displayed by financiers in dealing with the first surge of pandemic inspires confidence in their preparedness for the second wave.

What we have analysed:

* How the sector reacted during the onset of pandemic in Feb/Mar’20. Also, in the recovery phase, how swiftly did stocks rerate on expectations of activity revival? Where are stocks now trading vis-à-vis their historical averages and earlier peaks?

* What kind of war chest of liquidity, deposits, capital and credit contingency buffers, have financiers created to bear the brunt of economic and credit cycle disruption?

* Sector-wide and banks’ exposure to states where some restrictions have been reimposed, viz. Maharashtra, Gujarat, Punjab, Madhya Pradesh, Chhattisgarh, etc.

What we infer

* Though not a broad-based risk as of now, the daily intensity of rise in the number of cases and restricted economic activities / partial lockdown / night curfew do pose a risk of activity disruption and lower collections.

* Moderation in activity levels can dent business/consumer confidence and defer the revival of some vulnerable segments, e.g. hospitality, tourism, MSME, MFI, etc.

* Banks have created adequate deposit, capital and credit buffers to reduce earnings volatility. Also, we do not foresee any sharp revision in our credit cost estimates; we have already conservatively built-in higher credit cost for FY22E as well.

* Given capital, cost and operating efficiencies, and government’s thrust on reviving growth, visibility continues on medium and long term growth and RoE outlook.

* We will be watchful of these trends to gauge if earnings revision would be in order.

Can Covid resurgence and firming rates pose valuation risks?

* Acceleration in Covid cases, if prolonged for some more time with broadbased disruption risk, can shake investor sentiment and lead to some interim correction.

* Discount rate is also firming up with gradual uptick in risk-free rate (every 10% change in discount rate has ~20% sensitivity to the target valuation multiple).

* We tweak our coverage universe target prices by 2-4% to factor in these interim risks. Within our coverage universe: i) expectations are still lower for Axis, SBI, Bandhan, CUBK, Federal – all trading at 10-15% discount to historical averages; ii) resilience in performance is being displayed by HDFC Bank and Kotak, and their premium to historical average is rightly deserved; iii) earnings delivery will be on guided lines from Indusind and DCB. However, we fear risk of derating for Yes, RBL and AU SFB, where scope for disappointment could be relatively higher.

* Factoring-in warrant conversion, we increase Indusind’s target price to Rs1,013 (earlier: Rs975) maintaining ADD. Given recent under-performance of CUBK, we upgrade it to BUY from Hold, revising target price to Rs185 (earlier Rs190).

Our preferences continue to be: Axis Bank (target price: Rs942), SBI (Rs468), HDFC Bank (Rs1,730) and Federal Bank (Rs89).

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