SBI: Expect 40% return on stock over one-year period

We see upside across DuPont metrics for SBI that should see the bank’s ROEs reflate back to 13% by FY20E and 16% by FY21E. This, combined with valuation normalisation to last-cycle P/B levels (1.5x), could drive a significant re-rating over the next two years, in our view.

Our base view for the banking sector remains that deposit franchises will rerate vs. lending franchises and that NPLs across the system should start trending down from here. SBI is a key beneficiary of this thematic, and the bank, unlike other PSBs, has been able to maintain market share on both deposits and advances on a long-cycle basis. Subs are an added source of valuation delta medium-term. We expect a 40% return on the stock over a one-year period.

Margins for SBI have multiple levers for an upmove and benefit from MCLR (marginal cost lending rate) repricing, rising LDRs, lower NPLs (higher earnings asset base), pricing power and the bank’s market leading deposit franchise. Operating cost growth should tail off from Q4FY19 onward on lower gratuity provisions, with loan growth/merger synergies a source of medium-term operating leverage on PPOP.

We believe stress formation at the bank has peaked and is seen in GNPLs coming off 8% since Q4FY18. From recognition, we are entering a resolution cycle wherein eventual NPL recoveries have been much better than what the market estimated at the start of the year. A recovery trade is just starting and can last well into FY20/21, in our view.

Stripping out subsidiaries (at a 15% discount), SBI trades at a 0.8x FY20E P/B for the parent bank. This compares to a 1.5x P/B trading range over a more normalised time frame (2005-11) and 1.1x when NPLs in the system started creeping up (2011 onward).

State Bank of India