Up to 40% return! Morgan Stanley sees second leg of rerating coming to banks

Foreign brokerage Morgan Stanley (MS) believes the second leg of the rerating cycle is on the cards for the banking sector.

The brokerage finds ICICI Bank, Axis Bank, Bank of Baroda and SBI among stocks that are not fully pricing in a growth up-cycle, have access to retail deposits and high liquidity and appear well equipped to accelerate market share gains.

Morgan Stanley said Axis, SBI and Bank of Baroda (BOB) appear attractive, with room to re-rate further as core pre-provision operating profit (PPoP) growth accelerates. ICICI Bank, it said, is already trading at above mean valuations, but the brokerage believes its profitability and franchise are significantly better than history and think the stock has further room to re-rate.

For ICICI Bank, MS increased EPS estimates by 1.7 per cent for F23, 3.6 per cent for F24, and 4 per cent for F25 as it sees further moderation in credit costs. The target for this stock has been upped to Rs 1,225 from Rs 1,040.

MS hiked its earnings estimates for Axis, as a result of higher core PPoP growth, as it raised its loan growth and margin estimates. MS now sees Axis Bank at Rs 1,000 from Rs 910 earlier. SBI is well-positioned to capitalise on the upcoming turn in the macro cycle, the brokerage said while suggesting a target of Rs 675 (Rs 625 earlier).

MS sees the best risk-reward at BOB among SoE banks. As a base case, the brokerage has upped the target on this stock to Rs 170 from Rs 155 earlier.

"Unlike in past cycles, we believe retail deposit competitive intensity will be high, and the ability to gain deposit market share will be key. Large banks with higher liquidity and ability to gain deposit market share are best placed to capitalize, we think - ICICI, Axis, BOB and SBI are our preferred picks," it said.
Morgan Stanley said bank stock re-rating cycles work in two legs and that Indian banks appear to be in a transition phase between the two, it said in a note.

The first leg, it explained, is usually driven by expectations around better asset quality. As tail risks recede, stocks improve sharply to normalised multiples.

This phase happened over the past two years.

"The second, more sustained leg is usually driven by loan growth acceleration that sets an earnings upgrade cycle, and we believe catalysts for this are falling into place," it said.

Morgan Stanley said its macro team sees a new leg of the investment up-cycle led by improving trends in capacity utilisation rates, in addition to corporate sector profitability and de-leveraged banking sector balance sheets. This, in turn, could foster job creation, accelerate income growth, and drive more growth opportunities even in the retail/SME segment, the brokerage said.

Besides, MS said the competitive intensity in retail deposits would reach a new high in the upcoming up-cycle. Private banks, it said, have lagged on retail deposit market share gains and are turning aggressive.

"Moreover, LCR regulations and bank mergers would intensify competition. Large banks - both private and SoE - stand out and appear better placed to accelerate loan growth and gain share. We raise valuation multiples to reflect improved growth and profitability outlooks over the next few years," it added.


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