By Tejas MDThe month of October sparkled for Indian investors, with the Nifty 50 rising nearly 5% to cross the key level of 18,000 last week. It is now just 3% shy of a life-high. ICICI analysts predict that the Nifty will near 18,900 by December end. That would be quite a new year.
Global indices are also showing some spirit despite inflation fears. The US Dow Jones index posted a 14% rise – its best month in 46 years.
The US Federal Reserve delivered an expected 75 bps rate hike on Wednesday, taking the federal funds rate from 3.75% to 4%, its highest level in 15 years. But what investors were looking for from the Federal Reserve Chairman Jay Powell was any sign that the Central Bank plans to slow rate hikes going forward.
Fed watchers study Jay Powell with as much intensity as a mother may study a young child with a stomach ache. They parse everything from his expressions, his sighs, to his carefully chosen words. Before the meeting, Lloyd Blankfein, the former CEO of Goldman Sachs, joked that the Fed would be sitting with a thesaurus to find a word that meant both "pause" and "not pause".
Jay Powell managed to pull this off by disappointing everyone. He said that it was "very premature to think about pausing", but also said that the Fed "may slow the pace of increases."
Central Banks like the Fed and the RBI are caught between two fires: raise rates too fast and you trigger a recession, but go too slow and you worsen inflation. More rate hikes by the RBI could impact several sectors, and we look at one such sector this week.
In this week’s Analyticks,
- Young rockets: Private Midcap banks see growth momentum in Q2, as they benefit from rate hikes
- Screener: Stocks outperforming the Nifty50 and their sector post results, with rising operating profit margins and cash flows
India's private mid-cap banks beat the index
The banking sector has outperformed the benchmark index comfortably in the past month, quarter, and half-year. Banks are taking advantage of the Reserve Bank of India (RBI) raising the repo rate. RBI has raised the key rate by 190 bps since May to 5.9%. And high inflation levels mean that more hikes are on the way.
How does this help banks? Banks want the best of both worlds - they are quick to hike interest rates on loans (which adds to their income) but are slow to hike deposit rates (which they pay to account holders). So rate hikes by the RBI helps banks improve their net interest margin, since they benefit from the difference between the bank’s interest income and the interest they pay to their lenders.
However, banks cannot benefit from this for too long, as they need to hike rates on deposits eventually. Higher interest rates also bring down loan growth, especially in retail sector lending, which is mainly consumption driven. Companies also postpone their spending plans when interest rates are high, as businesses have to shell out more money to service loans.
So despite a sunny outlook by both analysts and banks, we are cautious. There are several factors that are potential roadblocks to rising net interest margins and strong loan growth.
Mid-cap banks join the party, and outperform their bigger peers
Mid-cap banks’ share prices are sharply up on the back of improving net interest margins, strong loan growth, and asset quality. The banks in focus–IDFC First Bank, Federal Bank, Karur Vysya Bank, and RBL Bank–outperformed the Nifty 50 by at least 12%, with Karur Vysya Bank leading the pack.
Over the past quarter, the stock performance of these banks has been even more impressive.
The rise in share price has come with strong results over the past three quarters. Q2FY23 results did not disappoint either. The revenue and net income of these banks rose sharply.
Several tailwinds like rising repo rates and strong loan book growth from high retail consumption, have helped banks post strong Q2 results.
Housing and vehicle loans were the star segments for banks in Q2.
But is this demand sustainable? Housing and vehicle loans may become less attractive with rising interest rates and analysts predicting more hikes in the coming months. In addition, according to CMIE data, new investment proposals by the private sector have been falling since Q1FY23. This could slow loan growth.
As if on cue, RBL Bank’s business loans (12% of the loan mix) decreased by 21% YoY in Q2FY23 and IDFC First Bank’s corporate banking loan book is yet to reach pre-covid levels. However, IDFC First’s management has guided a 25% loan book growth in FY23. Federal Bank and RBL Bank expect their loan books to grow over 15%.
The net interest margin (NIM) has been on the rise for all four over the past five quarters and accelerated in the last two-quarters, thanks to the rising repo rate.
NIM of the banks in focus rose both YoY and QoQ in Q2FY23. IDFC Bank enjoys the highest NIM among the four at 5.98%. Its management is confident about maintaining NIM at 6% in FY23.
Key ratios paint a bright picture
Banks provide several health-check metrics to assess asset quality, risk levels, etc. One key ratio is the gross non-performing assets (GNPA), which helps us understand the level of non-performing assets relative to total advances. This ratio has been on the decline for the past five quarters for the banks in focus, indicating a significant improvement in asset quality.
All four banks have also made rising provisions in case of future losses.
Another positive factor for these banks is their improving CASA ratio. The CASA ratio is the ratio of deposits in current and saving accounts to total deposits. The higher the CASA ratio, the better. A higher percentage indicates a lower cost of funds because banks do not usually give any interest on current account deposits, and the interest on saving accounts tends to be very low.
Current valuations look attractive, but there are potential roadblocks
Despite a sharp run-up in share prices, three out of the four banks in focus are in the PE buy zone.
According to Trendlyne’s DVM classification, IDFC First Bank and Karur Vysya Bank are strong performers (high on DVM scores) and are also in the PE buy zone – meaning that their PE ratios now are lower than historical levels.
While the outlook is strong for these banks, investors should keep in mind key risks going forward. Rising interest rates may slow down loan growth. Loan growth is also dependent on consumption-driven retail loans (especially in the housing sector), and rising mortgage rates could hurt demand in this sector.
Corporate loan books could also get affected as private companies cut back on spending due to fears of an economic slowdown and rising interest rates.
Screener: Stocks Outperforming the Nifty50 and their Sector, with rising Operating Profit Margin and Cash Flow
At a time of rising interest rates, having a healthy cash flow is important for companies to keep interest payments and debt low. This screener reflects stocks that are outperforming the Nifty 50 index and their sectors over the past month with a rise in operating profit margin and cash flow from annual operating activities. It also lists companies with TTM PE lower than their sector PE.
The screener results are dominated by the Banking and Finance sector with the Software & Services, General Industrials and Utilities sectors also turning up. Major stocks featured in the screener are Union Bank of India, Axis Bank, Persistent Systems, CG Power and Industrial Solutions, and Angel One.
Union Bank of India has the highest YoY growth of 126.6% in operating profit in Q2FY23. The company also saw a rise in annual cash flow of 77% in FY22. The stock outperformed the Nifty 50 index and the Banking and Finance sector over the past 90 days by 15.3% points and 13.5% points respectively. It also has a trailing twelve month PE of 6.1, which is lower than the sector average PE of 28.8.
Axis Bank has an 80.4% YoY growth of operating profit in Q2FY23. The bank has seen its annual cash from operating activity rise 122.7% in FY22. Over the past 90 days, the stock has outperformed the Nifty 50 index and the Banking and Finance sector by 18.3% points and 16.4% points respectively. It has a lower trailing twelve month PE than its sector of 15.2.
CG Power and Industrial Solutions has an operating profit growth of 51.7% YoY in Q2FY23. The company saw a rise in annual cash flow of 77% in FY22. Over the past 90 days, the stock has outperformed the Nifty 50 index and the General Industrials sector by 5% points and 4.2% points respectively. It also has a trailing twelve month PE of 41.1, which is lower than the sector average PE of 51.2.
You can find more screeners here.
