SBI: Earnings set to revive amidst uncertain macros; Risk-reward has turned favorable

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(SBIN IN, Mkt Cap USD33.3b, CMP INR265, TP INR350, 32% Upside, Buy)

–       State Bank of India’s (SBIN) earnings were suppressed for the past several years due to issues pertaining to asset quality, merger and an adverse rate environment. Even now, the macro environment remains challenging with high rating downgrades in the system, resulting in new names being added to the stressed pool. However, given SBIN’s size, we believe the new stress is manageable (~2% of total loans).

–        SBIN is well poised for an earnings recovery led by steady operating performance at the PPOP level (14% CAGR over FY19-FY21E), recoveries from large NCLT resolutions and normalization in credit cost to 1.9%/1.3% over FY20E/FY21E v/s average of 3.0% over FY16-19.

–       SBIN’s stock price has corrected 29% over the past three months, which provides favorable risk-reward, in our view. We conservatively expect RoA/RoE to improve to 0.7%/12.7% by FY21 and maintain our target price of INR350 (1.1x FY21E ABV for the bank + INR94 per share for subsidiaries). Maintain Buy.

Well poised for earnings recovery after a long lull

After reporting sub-optimal performance in the last few years due to high opex, interest reversals and provisioning pressures, SBIN is now well poised for an earnings recovery. The revival in earnings will be led by steady operating performance at the PPOP level (14% CAGR over FY19-FY21E), recoveries from large NCLT resolutions and normalization of credit cost over FY20E/FY21E v/s average of 3.2% over FY17-FY19. Further, reduction in the corporate tax rate from 30% to 22% should also support earnings; however, FY20E will be impacted due to one-time DTA reversal while full benefits will come in FY21 onwards. Overall, we estimate profits to grow to INR197b/INR288b in FY20/21 (v/s average PAT of INR70b for the past ten years), thus driving RoA/RoE to 0.7%/12.7%.

Subs getting bigger and better; Value unlocking to boost shareholder returns!

SBI’s subsidiaries – SBI MF, SBI Life Insurance, SBI Cards and SBI Cap Securities have displayed robust performance in the last few years. SBI plans to monetize several of its subsidiaries, which would lead to further value unlocking for stakeholders. We note that at CMP, SBIN’s subs are accounting for ~35% of total valuation and the bank is trading close to its lowest valuation (0.7x FY21E ABV) – at least for the past five years (including AQR period) – please refer exhibit 33 for details.

SBI Cards: It has a market share of 17.8% on a card base of 8.8m and 17.1% in card spends. It has seen 50% CAGR on card spends from FY17-19 while PAT CAGR over a similar period was 42% (PAT further grew at 104% YoY in 1QFY20). Return ratios have remained healthy with RoE at 30.2%. Also, we see biggest upside in valuations in this subsidiary.

–       SBI Life Insurance: It has delivered ~26% CAGR in un-weighted NBP over FY15-19 (v/s 20% for private players) with VNB margin of 17.7% as at FY19 (17.9% as on 1QFY20). It has one of the lowest cost structures with total expense ratio at 11.2%, thus, enabling it to deliver ~17.5% RoEV.

–       SBI Asset Management is the third largest AMC with total AUM of ~INR3.1t and a market share of ~12%. AUM has grown at robust 40% CAGR over FY15-19 while PAT reported CAGR of 27% to INR4.3b in FY19 with RoE of 31.1%.

–       SBI General Insurance has delivered ~31% CAGR in GWP over FY15-19. PAT grew 26% YoY to INR3.3b in FY19 from INR2.6b in FY18 with RoE of 20.1%.

Reduction in SA rate to help offset margin pressure

The linking of floating rate retail and MSME loans to external benchmark will bring in more volatility to bank margins. However, SBIN has higher share of CASA deposits, which puts the bank in a better position to manage yield pressure on the asset side. SBIN has already linked SA balances above INR0.1m to the repo rate, which stands at 3% (at floor level, unchanged after the last policy rate cut) and has recently announced reducing the SA rate on balances up to INR0.1m to 3.25% from 3.5% w.e.f 1st Nov’19. We believe that this will help offset the margin pressure and will gradually become an important tool to control funding cost.

C-I ratio to improve over FY19-21E; Staff provisions to moderate sharply

SBIN has made additional provisions towards wage revisions (INR39.8b) and enhancement in gratuity limit (~INR27.1b) over FY19, which led to elevated operating expenses. Management has guided for curtailing INR19b of wage related provisions over FY20E (~50% reduction over FY19). We also expect rationalization of branches and improved efficiency due to technological initiatives undertaken by the bank on the digital front, which will help in controlling operating expenses. Thus, we expect SBIN’s C/I ratio to improve to ~52% by FY21E v/s ~56% in FY19.

Macro uncertainty remains; Stressed exposures (excl. NPA) controlled at ~2% of total loans   

The macro environment remains challenging with high rating downgrades in the system. This has resulted in new names being added to the stressed pool. Our deep-dive analysis of stressed accounts suggests that SBIN’s exposure to the new stressed pool constitutes ~2% of total loans, which appears manageable. We build in elevated credit cost of 1.9% /1.3% for FY20/FY21, which will get partly offset by the NCLT linked write-backs. We, thus, expect GNPL/NNPL ratio to decline to ~5.0%/1.7% by FY21 while PCR should improve to ~66% from ~61% in 1QFY20.

–       Sectoral analysis shows that SBIN’s NPL ratios have improved sharply with large and mid-corporate/SME NPL ratios improving to 13.6%/8.6% as of FY19, while agriculture NPLs have increased by 31bp to 11.6%.

–       The SMA 1 and 2 for the bank stood at INR102.9b (~0.5% of loans) in 1QFY20.

Valuation and view

The macro environment remains challenging with new names being added to the stressed pool. While SBIN has exposure to the stressed names, we believe that given its size, the new stress is manageable (~2% of loans), however, we have conservatively factored in credit cost assumptions of 1.9% /1.3% for FY20/FY21. SBIN’s liability side of the balance sheet is strong with high CASA ratio, which will help manage yield pressure on the asset side due to transition to the new external benchmark regime on floating rate retail & MSME loans. The stock price has corrected 29% over the past three months, which provides favorable risk-reward, in our view. Overall, we expect RoA/RoE to improve to 0.7%/12.7% by FY21 and maintain our target price at INR350 (1.1x FY21E ABV for the bank + INR94 per share for subsidiaries). SBIN remains one of our top Buys in the sector.

(Report by Motilal Oswal Institutional Equities)