Sometimes, the very best investment opportunities can come down to swimming against the tide and there are few better examples of this right now than the leading private sector banks in India, write Abhinav Mehra and Andy Draycott, co-managers of the Chikara Indian Subcontinent Fund.
The consensus among investors today is that Indian equities are expensive. And there’s a decent argument to be made that this, on the whole, is true.
However, when you dig deeper it quickly becomes clear to us that there are exceptions to this rule. Many overlooked areas exist in this market that are poised to deliver outsized returns.
Against a backdrop of expanding market share and growing demand, we believe one of the best examples of this can be found in India’s private banks.
Searching for value
According to an article published by Fidelity, India’s stock market traded at an average of 20 times expected earnings in mid-August. That was not only in line with Wall Street, but also double China’s 10 times earnings multiple at the time.
But investors should bear in mind two important pieces of context.
First, Indian equities generally carry a higher valuation for good reason.
The nation is among the most consistent in terms of long-term performance, and its growth prospects remain strong thanks to its relatively young population and rising GDP per capital. Indeed, India is expected to be the world’s third largest economy just four years from now.
Second, and perhaps most importantly, while the market as a whole may be perceived as expensive, pockets of value very much remain. It’s just about knowing where to look.
A good example of this is India’s private banking sector.
The fundamental case when it comes to these stocks is – and has long been in Mehra and Draycott’s opinion – very strong. India’s private banks have been consolidating their position and increasingly taking market share from public sector state-owned banks for years now.
Combine this expanded footprint with general growth in demand for banking services amongst an increasingly wealthy Indian population, and it’s unlikely to come as a huge surprise to learn that some of India’s private banks have been delivering impressive returns.
In fact, according to Statista, they collectively posted net profits of 962.2bn rupees (£9.2bn) in 2022 up from 694.77 bn rupees (£6.87bn) in 2021, a year-on-year jump of nearly 40%.
This isn’t just being driven by new entrants, either. The established private banks are key here.
Take HDFC Bank and Kotak Mahindra Bank, for example.
HDFC reported year-on-year revenue growth of 25.9% and net profit growth of 29.1% in the quarter ended 30 June 2023. Kotak, meanwhile, revealed a 51% year-on-year leap in consolidated profit, after tax, over the same period.
This strong performance and positive outlook alone should earn a second glance from many investors. But what makes India’s private banks so interesting right now is the fact they are being overlooked by the general market.
Perhaps this is due to the aforementioned consensus view of Indian equities as expensive. Or, in the case of the banks, concerns over the recent merger between HDFC Ltd. and HDFC Bank and a new CEO at Kotak.
Alternatively, it can be argued that some investors find comfort in popular and more recognisable stocks in the MSCI India index, such as Infosys or Unilever.
Whatever the reason though, the net result is that some private bank valuations are not rising at the same rate as earnings. As a result, these banks are trading at their lowest price-to-book ratio in years.
HDFC Bank, for example, is trading at a price-to-book ratio of 2.1x. That’s near the levels at which it traded during the Global Financial Crisis.
Likewise, with a price-to-book ratio of 3.1x, Kotak is trading at its lowest level since the end of 2013.
Ofcourse cheap doesn’t necessarily equal good and sometimes stocks trade lower because they aren’t as fundamentally strong as they once were, and it doesn’t look like that will change.
Mehra and Draycott are confident that this is not the case with India’s private banks.
They believe they are strong today; and if they continue to acquire market share from the state-owned banks and deposits continue to grow in the face of forecasts of a more-than-doubling of India’s GDP to more than US$7.5tn (£6.7tn) by 2030, they will only likely get stronger.
Both Mehra and Draycott think it will become increasingly difficult – even more so than it is today – to ignore the disparity between this strength and their valuations.
A matter of time
Entirely writing off Indian equities as expensive represents, in our view, a missed opportunity. The market continues to offer areas where balance sheet strength and positive outlook are undermined by stock market performance.
India’s private banks provide an excellent example of this, and we’re confident that early investors will enjoy oversized returns where the disparity inevitably corrects.