Public sector banks have been conservative, and derived a chunk of their income from treasury profits. This could be due to the falling interest rate environment, prudential; regulation for SLR, and so on. On the other hand, private banks were aggressive and diversified to garner higher income, thus overtaking their peers with better customer service, risk management and IT skills. Public sector banks have started adopting these measures. And with large branch networks, they are in a better position to leverage their investments to provide better customer services. The management focus of the public sector banks in restructuring their regulatory initiative of risk management, and their technology initiative may enable them to capture some of the opportunity with low cost base.
There is a wide valuation gap between the public and private sector banks are trading at a discount to their private counterparts. This could be due to differences in the growth outlook as the private banks are growing much faster.
Strong loan growth in line with sector trends, a substantial improvement in cost ratios, strong balance sheet growth and the various technology initiatives taken by the public sector banks should narrow the valuation difference between private and public banks.
Therefore on the basis of the above, we present two banks namely Bank of India and Corporation Bank, which we believe are fast catching up with their private counterparts. In addition these banks have reflected strong operating as well as financial performance in the last two years. Going forward, too, these banks are well positioned to witness continued growth and therefore deserve higher valuations. These stocks in turn present opportunities for investors to invest in these stocks.
Bank of India: At the current market price of Rs 326, it trades at 1.9xFY08 book value 8.5xFY08 EPS. The past financial performance has been impressive. The asset quality is improving. Dominant presence in the western region and expanding international operations will drive future earnings for the banks.
Corporation Bank: At the current market price of Rs 335, it trades at 1.1xFY08 book value and 6.4xFY08 EPS. Since it is the most efficient bank in south, there is a positive outlook, due to its efficient operations reflected in low operating expenses, superior asset quality, and investments in technology.
The change in the structure of the industry has resulted in the market imputing higher value to private sector banks as they are in a position to capture the opportunities faster.
The management focus of the public sector banks in restructuring; regulatory initiative on risk management and technology initiative may position them to capture some of the opportunity with low cost base.
Indian private banks have historically traded at a significant premium to the valuations of public sector banks. Private sector banks have demonstrated strong growth and market share gains. They have been perceived as significantly ahead of public sector banks on products, service levels and management. And they are strong on technology. There are concerns about the industry like asset liability management. There is a need for transparency in pricing of loans by banks so as it ensures that the BPLR reflects the true cost. Recent market developments have highlighted the vulnerabilities created by off balance sheet exposures, and issues relating to liquidity risk management by banks.