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Realigning MOdel Portfolio to ride the earnings wave!

Remain OW on Banks v/s NBFCs; ICICI, AXSB, SBI top OWs | Add IIB, HDFCLIFE and BOB

The MOFSL BFSI MOdel Portfolio delivered a strong outperformance of ~150bp since our iteration in Nov’21 (cumulative outperformance of ~134bp since inception) to the underlying benchmark (Nifty Financial Services Index) propelled by our OW stance on Banks (ICICI, AXIS and SBI). NBFCs too supported the outperformance even as vehicle financiers underperformed, while select alpha ideas (ANGELONE and IIFLW) also contributed well to the overall portfolio outperformance. The 3QFY22 earnings season started in the shadow of OMICRON wave; however, the growth momentum remained unscathed and banks overall reported strong momentum in earnings. We realign our MOdel Portfolio to ride the ongoing earnings wave and maintain our OW stance on ICICIBC, AXIS, and SBIN among major banks. We have moderated our weights marginally for MUTH and ISEC and reduced our UW stance on HDFCB as the stock has underperformed significantly and earnings traction is likely to improve over FY23. We retain our UW viewpoint on most NBFCs while within insurance space SBILIFE remains our top OW. We have added IIB, HDFCLIFE and BOB to the model portfolio as valuations look attractive in the context of potential earnings recovery.

BFSI outperforms Nifty over recent months; stock performance divergent

* During FY22YTD, NSEFIN/Bank Nifty underperformed the Nifty by ~6%/4% while stock performance remained quite divergent. During the past two and a half months since our last version of the BFSI model portfolio, Bank Nifty has outperformed Nifty by ~3% led by (a) improving earnings growth and favorable outlook given the revival in economic activity, (b) improvement in asset quality along with reduction in SMAs/restructured loans, and, (c) sharp revival in loan growth. The NSEFIN/Bank Nifty have delivered 9%/11% returns in FY22YTD against 15% returns in the Nifty-50.

* Further analysis indicates a strong performance from key stocks over FY22YTD such as ISEC (+89%), BJFIN (+62%), CBK (+54%), BoB (+43%), SBIN (+38%), BAF (+32%), ICICIBC (+29%), FB (+27%), IIFLW (+24%) and SBILIFE (+24%).

BFSI MOdel Portfolio delivers sharp outperformance of 150bp

* MOFSL BFSI MOdel Portfolio has delivered a strong outperformance of ~150bp since our iteration in Nov’21. Thus, since its inception in Jun’21, the portfolio has delivered an outperformance of ~134bp amid a challenging operating and macro environment. We note that the outperformance was largely driven by Banks (+81bp) while Insurance (+46bp) and NBFCs (+25bp) too contributed to the overall portfolio performance.

* Banks (OW) - Our OW stance on our top ideas – SBIN, AXSB and AUBANK – which delivered returns of 2-14% v/s -1% by the Bank Nifty. This was further supported by our UW stance on HDFCB (-3%) and KMB (-14%).

* NBFC (UW) outperformed 25bp led by our UW stance on HDFC, which saw a decline of 20%, and BAJAJ Group. This was partially offset by underperformance of vehicle financiers and MUTHOOT.

* Life Insurance (UW) sector witnessed a healthy outperformance of 46bp led by our UW stance on HDFCLIFE and ICICIGI, which declined ~14-19%. Our top pick, SBILIFE declined by a modest 5%.

* Non-lending financials – ANGELONE and IIFLW outperformed as they delivered ~3% returns with cumulative outperformance of 6bp. This was supported by HDFCAMC (+7bp), while SBICARD underperformed due to pressure on revolve rate/NIMs and uncertainty around the MDR charges.

Earnings outlook encouraging, pick-up in loan growth to be the next lever

* Most of the banks have reported their 3QFY22 earnings and the growth momentum has accelerated during the quarter fueled by a sharp pick-up in corporate portfolio while growth in retail, business banking and SME segment also stood healthy. NII growth thus picked up and was supported by steady margins. We expect the growth momentum to remain healthy as the economic activity recovers while capex cycle also revives over FY23. Thus, we estimate systemic loans to grow at 9%/13% over FY22E/FY23E, respectively.

* Asset quality trends have improved and most of the banks reported a decline in their NPL ratios while SMA/restructured book also declined. The improvement was led by controlled slippages and healthy recovery and upgrades as banks continue to lay their efforts on collections. We expect credit costs to remain in control as most of the banks are carrying adequate provisioning buffer.

* The asset quality outlook for PSBs is improving which along with a healthy uptick in operating performance enabled PSU bank index to deliver a return of 12% since Dec’21. SMA book across banks have moderated which augurs well for incremental slippage to remain controlled which coupled with healthy PCR in the 65–77% range would keep the credit cost under control. Therefore, PSBs are well-placed to deliver a strong rebound in earnings as we estimate FY22E PAT to be ~10x of the sum of FY17–21 PAT, while FY22–24E earnings would grow at a healthy 32% CAGR. We estimate RoA/RoE to improve to 0.9%/13.7% for FY24E v/s 0.4%/6.1% for FY21. The current valuations of PSBs (barring SBIN) at 0.5– 0.7x FY23E P/ABV do not fully price in the forthcoming RoE recovery. SBIN remains among our top pick while we added BoB to our model portfolio.

* For NBFCs, demand continues to improve notably across product segments – Mortgages, Vehicle Finance, SME, Personal Loans and B2C Consumer Finance. While there was an organic improvement in asset quality during the quarter, RBI’s NPA circular led to deterioration in the reported Gross Stage 3/GNPA numbers by the players within the NBFC/HFC segments. This classification of <90dpd loans in Stage 3/GNPA even led to an increase in credit costs during 3QFY22. We expect 4QFY22 to be strong for the NBFC lenders driven by strength in disbursements as well as improvement in asset quality.

* Non-lending Financials: Since Nov’21, Indian equity markets have seen increased volatility with the gap between intraday high and low of Nifty averaging 1.3% v/s 1% during Apr-Nov’21. In spite of this, there has been a substantial increase in trading activity with retail segment ADTO in Jan’22 being 22% higher than Oct’21. The demat account addition momentum has sustained with an addition of ~7m accounts in Nov’21 and Dec’21 (total 81m accounts). Active user client base on NSE continues to rise at the pace of 1.7m clients per month (total 31.5m clients).

Banks (OW): We tweak our MOdel Portfolio to reflect our view on the growth environment, led by an uptick in economic recovery, improving asset quality and encouraging earnings outlook as the third wave has receded quickly with negligible impact.

* We maintain our OW stance on ICICIBC, SBIN and AXSB as the valuations remain attractive, while return ratios will improve further driving continued re-rating.

* We reduce our UW stance on HDFCB (-276bp) as the stock looks attractive while we expect PPoP, NIMs and loan growth to gain traction in the coming quarters. We remain UW on KMB (-256bp).

* NBFCs (UW): We retain our UW standpoint on HDFC (-242bp) and the Bajaj Group (-210bp) as both these otherwise strong franchises will lag in preference v/s banks and will thus continue to underperform in our opinion. We remain moderately OW on SHTF even though the stock has corrected significantly after the merger announcement as we believe that it will stand to benefit from an expected CV up-cycle and strong demand in used-CV market. We are Equalweight on CIFC as valuations adequately capture the operational performance in our view though there could be potential optionality value from the newer SME and Consumer ecosystems that the company has entered. Moreover, we are OW on MUTH (+97bp) for the relative safety it offers in these uncertain times.

 Life Insurance (UW): We are OW on SBILIFE (+72bp) and IPRU (+49bp) on an improving business mix, cost control, and healthy VNB growth, underpinned by steady margins.

* Non-Lending Financials: We remain OW on ANGELONE (+100bp) given the strength in industry dynamics and better-than-estimated 3QFY22earnings. It also continues to depict robustness in business model as the number of trades rose 19% MoM in a volatile Jan’22. Conversely, we reduce our OW view in ISEC (+50bp) as retail brokerage revenue remains muted (flattish over the past seven quarters). Among others, we are OW on IIFLW (100bp) and SBICARD (50bp).

* New Additions / Deletions: We introduce IIB, HDFCLIFE and BOB in the MOdel Portfolio with 1%/1%/0.8% weight, respectively, as we believe that their earnings are likely to grow faster while valuations stand attractive. We have removed AUBANK from the MOdel Portfolio given its robust outperformance even as we remain positive on its underlying business.

Encouraging outlook buoyed by likely loan growth and strong asset quality

* We remain constructive on the sector as we expect loan growth trends to revive further. On the other hand, asset quality has been holding up well, and the outlook remains encouraging. We expect systemic loans to grow 9%/ 13% over FY22E/FY23E, respectively.

* The adequate contingency buffers held by banks as well as the controlled credit costs would enable decadal high RoEs for the Banking sector. We estimate private banks’ RoA/RoE to improve to 1.9%/16.7% by FY24, while we estimate FY24 RoA/RoE of 0.9%/13.7% for PSBs.

* We continue to prefer large cap banks as their valuations appear reasonable given the earnings outlook. They have displayed a better ability to deal with macro uncertainties and have stronger balance sheets.

* ICICIBC, SBIN, and AXSB are our top large cap picks. Among mid-size banks and NBFCs we prefer MUTH, SHTF, IIB and BOB.

* Among the non-lending financials, we prefer SBILIFE and IPRU within life insurers and ISEC, IIFLW, and ANGELONE among other financials.

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