PSU bank stocks not cheap anymore; time to be selective: Experts

PSU bank stocks: The public sector undertaking (PSU) bank index Nifty PSU Bank has rallied over 72 per cent in a year. All the constituents of the index have given positive returns. Names such as Indian Overseas Bank, Punjab National Bank, Punjab & Sind Bank, Central Bank of India, and Bank of Maharashtra delivered multi-bagger returns, surging between 102 per cent and 136 per cent during the period.

What's driving the rally in stock?

As per analysts, PSU banks are the leaders of the segment and have rallied due to the following reasons:

• Banking reforms such as the establishment of bad banks to move the long-standing non-performing assets (NPA) out of the books, have benefited the PSU lenders.
• Implementation of the Insolvency & Bankruptcy Code helped banks recover their debts.
• Merger of several PSU banks enabled them to have a more focused approach towards their operations.
• The government's focus on long-term projects in infrastructure, power, and agriculture aided PSU banks more than private banks, as they traditionally have higher exposure in these sectors.
• The government's concentrated holding creates a supply-demand mismatch that propels the share price upward. The change in perceptions and low float resulted in a gigantic rally in PSU banks recently.

Vaibhav Jain, Head of Content & Education, Share. Market Research opines that robust earnings growth, enhanced asset quality, and resilient balance sheets of PSU banks have fueled a sustained rally in their stocks for over a year.

As per Mohit Gang, CEO, MoneyFront, the rise in PSU bank stocks can also be due to a decrease in gross NPAs and an improvement in capital adequacy ratios (an indicator of how well a bank can meet its obligations). "All this has led to a significant re-rating in the valuation and perception of public sector banks in India. Most of them were trading sub-one times on price to book multiple, and hence, investors drew a lot of comfort from cheap valuations plus a significant uptick in business and improvement in balance sheets," said Gang.

What should investors do?

MoneyFront's Gang advocates caution for investors at current levels, as the sector has run up a lot in the last one year and is no longer cheap on valuations.

"One has to be very selective in entering this space now. Perhaps the better pockets in this space are now the larger names in the pack, whose valuations are relatively comfortable. Additionally, this will also give some cushion to investors in the event of a market correction," said Gang.

According to Tanvi Kanchan, Head of UAE Business & Strategy, and Anand Rathi Shares and Stock Brokers, the valuations look stretched as PSU bank stocks are currently trading at the highest levels compared to their historical valuations.

"The PSU banks had a phenomenal rally in comparison to the broader Nifty Bank index. If we look at historical averages for some of the PSU banks, they are trading at an all-time high, and looking at valuations for a few of them, they do look stretched from a long-term average point of view. Now appreciation of stocks happens because earnings growth and perception lead to growth or multiple expansion, and the current rally of PSUs is more in terms of multiple expansion than actual earnings growth," said Kanchan.

Multiple expansion is when the valuation of a stock rises faster than the stock’s fundamental value. 

Kanchan added that given the present lofty valuations of the PSU banks, perceptions led to momentum, and based on the price action of private banks, it would be prudent to add private banks to the portfolio. Investors stand to benefit by pivoting towards private banks with potential and avoiding PSU banks, which are overvalued.

On the other hand, Bigul’s research team reckons that in the coming quarters, if banks continue to post good earnings, then more upward momentum is possible in PSU bank shares.

"Keeping a bullish view for the two SBI and Bank of Baroda stocks because the technical chart structure draws an uptrend. Furthermore, both banks had a low NPA ratio as compared to other PSU banks," said Bigul's research.

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