Bank stocks: Interesting bet for investment

The BSE Bankex was the worst performing sectoral index on Tuesday,
shedding nearly 8%, steeper than 5% drop in the benchmark Sensex. The
Bankex has more than halved in 2008 following fears of economic
slowdown. The banks have to face twin challenges in the form of rising
interest rates. First, the value of investment in government
securities (g-sec) declines. Further, the loan offtake slows down as
cost of borrowing increases. Yet, for all these negatives, the sell-
off in some of the private bank stocks may have been overdone.

Indian banks typically hold g-sec with a maturity of two years. The
yield rate of such a security has gone up from 7.5% at the end of
March '08 to 9.2% at present. This implies a fall of 3% in the value
of investment. Less than 20% of the total g-sec investments of private
sector banks like ICICI Bank, HDFC Bank and Axis Bank fall under the
category of available for sale securities unlike their public sector
counterparts.

This makes them less vulnerable to rising interest rate. However,
private bank stocks have been treated at par with public sector banks,
though their exposure to g-secs are much lower. This shows that the
investors are increasingly worried about the growth in the loan book
of private banks in FY09.

The top two private sector banks — ICICI Bank & HDFC Bank — have
recorded healthy growth rates in profits in the last two financial
years. Net profit of HDFC Bank grew by 40% in FY08, while that of
ICICI Bank increased by more than 30%. The high growth rates were
reflected in the price to earnings (P/E) multiple of these banks.

When the markets reached its peak in January '08, HDFC Bank was
trading at a P/E of 50 and ICICI Bank was trading at a P/E of 36. It
is evident that the stock prices had increased much more than the
growth rates implied by the earnings.

At current prices, the stocks of HDFC Bank and ICICI Bank are trading
at a P/E multiple of 24.5 and 14.2 respectively. This means analysts
are expecting the balance sheets of these banks to grow by over 20%
considering that the profit growth will depend solely on the business
growth rather than improvement in net interest margin (NIM).

On the other hand, the stocks of Axis Bank and Yes Bank are trading at
a P/E of less than 20. Both these banks are on a much higher growth
trajectory than the two biggest private sector banks. This is evident
as Axis Bank witnessed 90% growth in its profit in the June '08
quarter. Experts feel that the low multiples of these two banks and
high growth trajectory make them interesting bets for investment.