Emkay Global in its latest strategy note said it sees a short-term rally in financials but believes one should sell on rise. HDFC Bank, IndusInd Bank, RBL Bank and Shriram Finance are Emkay's key picks to play the short-term rally.
The brokerage said it sees as rally in financials ahead, due to potential deposit growth recovery, as the RBI begins its easing cycle. The banking sector, it said, remains an island of optically moderate valuations that is triggering a TINA factor for investors. TINA stands for "there is no alternative". The Nifty Bank index is up 6 per cent in the past one month and 16 per cent in the past six months.
Emkay Global said the rally in financials should not last beyond a quarter, as margins come under pressure when repo rates are eased. "Longer-term, we see lenders still overvalued, with fair-value ranges at 1.5-1.7 times PBV vs current levels of 2-2.8 times. This is a short-term trade, and long-term investors should use this rally to lighten weightage," Emkay Global said.
Easing of domestic liquidity has been a short-term powerful catalyst for lenders in the past and Emkay sees this already starting to play out. This time, the impact is likely to be more pronounced because of the narrative of a deposit shortage, Emkay Global said.
"We believe the slump in deposit growth is entirely due to system liquidity as it tracks M3 growth very closely. We believe that deposit growth will bounce back as soon as the RBI reverses is stance, leading to a significant shift in sentiment for lenders," it said.
Nifty's 1-year forward PE ratio at 24 times is up 46 per cent since March 2023. This has pushed large parts of the market into overvalued territory.
"On the other hand, the PE ratio for financials has seen its discount to the Nifty PE expand, from 20 percent to 25 per cent in the same period. IT is also the cheapest sector in the Nifty, barring energy. Lack of options for investors looking for reasonable valuations combined with the positive trigger of easier liquidity is pushing the short-term rally in Financials," Emkay said.
"We see this as a short-lived rally. Rate cuts in 3QFY25 would lead to margin cuts in 4QFY25 for most major banks, given that mortgages (30 per cent of loan book for most large banks) re-price immediately. Also, banks may delay deposit rate cuts due to the recent tightness and HDFC Bank's need to replace deposits of the erstwhile HDFC Ltd borrowings. Moreover, the structural adjustment to bank valuations is still WIP. We believe that with growth rates and ROEs in the mid-teens, the fair value for large banks is 1.5-1.7 times PBV. Banks will continue to derate till they settle at these valuations," it said.