Banking sector valuations appear reasonable after strong 2023: Report

Banking sector outlook: The banking sector staged a notable recovery in 2023 in the last two months, enabling it to deliver a commendable 12 per cent return despite facing various macro concerns, including high interest rates, geopolitical events and regulatory tightening by the Reserve Bank of India (RBI).

Banks staged robust aggregate earnings growth of 48 per cent in FY23. The growth was predominantly driven by 59 per cent annual increase in earnings for PSU banks, while private banks reported 41 per cent earnings growth in FY23. The sector's FY20-23 earnings CAGR stood at 53 per cent with PSU banks posting an impressive 100 per cent compounded annual growth rate (CAGR) and private banks at 37 per cent.

For FY24-26, brokerage firm Motilal Oswal expects a moderate 21 per cent earnings CAGR, with a similar growth trajectory expected for both private banks and PSU banks. Noteworthy upgrades were observed in FY24 earnings for specific banks with Canara Bank, RBL Bank, and Union Bank leading the pack with significant percentage changes in consensus estimates.

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PSU banks and regional banks emerged as the top performers in 2023, delivering returns in the range of 60 to 120 per cent. Large private banks yielded modest returns, with Axis being the top performer at 18 per cent. Mid-size banks exhibited varied returns, with some underperforming.

FII Flows and valuations

FII flows rebounded strongly toward the end of 2023, reaching Rs 1.7 lakh crore. The solid balance sheets of the banking sector, a steady growth outlook and healthy return ratios were key enablers for robust FII flows.

Valuations in banking sector still appear reasonable, considering pristine balance sheets and steady profitability ratios, Motilal Oswal said.

“The changing narrative on interest rates globally and India's sustained economic growth dominance present numerous opportunities for the banking sector in the medium term. While asset quality remains steady, a close watch on trends in unsecured retail and MSME segments is essential to control credit costs. The sector is poised to deliver double-digit returns in 2024, with expectations broadly comparable to underlying return on equity,” the Mumbai-based brokerage said.

Top Picks

Motilal Oswal’s top picks in banking sector include ICICI Bank, IndusInd Bank, State Bank of India, and Union Bank.