Systematix Institutional Equities in its latest note on banking sector said while the current de-rating in banking stocks may seem appealing to investors and is causing sporadic spurts, the sector is still at the advent of a normalisation process amidst the underlying macroeconomic imbalances. It maintained an underweight position on the sector and said it would be selective in its stock picking going ahead.
"The performance of Bank Nifty is susceptible to a downside risk in the normalization phase and the anticipated reduction in the CD ratio, which is at an advent of an inflection point, can extend the underperformance. The fall in CD ratio could extend the pressure on margins, reduce return ratios and increase NPAs, collectively leading to further pressure on valuations," Systematix Institutional Equities said.
The brokerage said there is a high correlation between Nifty Bank price-to-book (P/BV) ratio and total allocation of banks-to-total liabilities at 0.84. A 300 basis points decline in the credit-deposit (CD) ratio 74-75 per cent levels would imply trailing Nifty Bank P/BV ratio falling from the current levels of 2.8 times to 2.4 times.
"Within this, PSBs are more susceptible as their valuations have risen more sharply; P/BV of Nifty PSB rose to a recent peak of 1.7 times in May 2024 from the pre-Covid levels of 0.8 times and is currently at 1.3 times. Large private banks such as HDFC Bank and Kotak Bank have underperformed and are currently at a 14-year low valuation and hence they are less vulnerable. ICICI Bank has seen significant re-rating, currently at 3.5 times P/B (trailing) and can be susceptible to the risks of sectoral de-rating," it said.
Systematix Institutional Equities said the broader Nifty 500 saw a significant re-rating to 4.4 times P/BV against the pre-Covid level of 3.5 times (trailing), while Nifty Bank has de-rated from 3.3 times pre-Covid to current 2.8 times.
"Hence, the valuation gap between the banks and the other major components reflects the structural quagmire that the banking sector continues to face. Given our structural and cyclical assessment the undervaluation situation of banking and lending sectors will likely persist notwithstanding the intermittent short rallies amid sector rotations. Hence, our Underweight view on banks and NBFC is maintained. We prefer lenders in affordable housing (Home First) and gold finance (Muthoot Finance)," it said.