Tactical pick – SBI

This week’s tactical pick is State Bank of India (Current market price: Rs 336).

SBI’s earnings in the latest quarter and management commentary suggest that a big turnaround in profits is round the corner for India's largest bank.

SBI reported standalone net profit of Rs 838 crore for the quarter ended March, much below Street expectations, on a spike in loan loss provisions. While the profit and loss statement bled, the balance sheet strengthened with significant improvement in the provision coverage ratio (PCR).  Operating performance was good, marked by a strong loan growth, better margins and most importantly receding asset quality issues.

SBI stands out because of its sheer size and better operating performance among public sector banks, which are fast losing their mojo in the financial system. We expect a faster recovery for SBI than many small- to mid-sized public lenders. As fresh impairments have abated and the under-provisioning gap has narrowed, we see credit cost declining, lifting earnings.

The management had earlier outlined its strategy to deliver consolidated return on asset (RoA) of 0.9-1 percent while improving GNPA to below 6 percent and maintaining provision cover above 60 percent by March 2020. Now that much lower slippages can be expected, which will lead to normalisation of credit cost, the target looks achievable. While the bank’s capital position is adequate for near-term growth, it is likely to raise equity in FY20, which will be a key catalyst for the stock.

That said, SBI’s size, its biggest strength, can turn out to be biggest risk in two ways. First, SBI stepping forward to bail out weaker public sector banks or troubled NBFCs cannot be ruled out.  We have already seen SBI providing liquidity to NBFCs by buying loans from them in the aftermath of the liquidity crisis. Second, SBI cannot emerge unscathed from any macro-economic slowdown.

While both these fears are not unfounded, we are encouraged by the improving outlook, with earnings set to take a big leap.

While FY19 was a year of consolidation, FY20 is likely to be the year of earnings revival. With multiple levers for improvement in return ratios, the current valuation of one-time FY21 estimated book value of the core business looks undemanding. With a turnaround in sight, investors looking to play the asset recovery and resolution cycle should buy into the stock as a long-term bet.

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