BFSI sector valuation discount at new high

Companies in the banking, finance sector and insurance (BFSI) sector have underperformed on the bourses despite leading the earnings growth charts in the post-pandemic period.

This has created a dichotomy between their earnings and share prices.

BFSI companies have never been less expensive than the rest of the equity market.

BFSI companies’ valuation discount over non-BFSI companies and the broader market is now the highest since at least 2011.

The top listed BFSI companies are currently valued 2.62 times their book value at the end of FY24, less than half the non-BFSI companies’ current price to book value ratio of nearly 5.6.

The numbers suggest the segment of the Indian equity market has become expensive over the years but the valuation re-rating has been much sharper for non-BFSI companies in sectors such as information technology services, automotive, consumer goods, defence, industrials, and metals.

In contrast banks, non-banking financial companies, and insurance firms saw only a modest rise in their valuation in recent years.

Historically, non-BFSI companies have always traded at a premium to their BFSI peers, but the premium was consistent during the pre-pandemic period and ranged from 50-100 per cent and it averaged 68 per cent between FY11 and FY20.

The premium has since exploded and it continues to rise. (See the adjoining chart.)

For example, the price to book value ratio of non-BFSI companies doubled in the past five years from 2.8.

In contrast, BFSI companies’ valuation is up just 24 per cent in the past five year from 2.1 at the end of FY19 and it’s up only a third since March 2021. (See the adjoining chart.)

This has been partly attributed to a relatively slow rise in the share price and market capitalisation of BFSI companies.

BFSI companies’ valuation has also suffered from faster growth in their earnings and book value.

The analysis is based on a common sample of 1,021 companies from the BSE500, BSE Mid-Cap and BSE Small Cap index.

There are 123 BFSI companies in our sample and 898 non-BFSI companies.

These companies had combined market capitalisation of Rs 437.4 trillion on September 25, accounting for 93 per cent of the combined market capitalisation of all companies listed on BSE.

The combined market capitalisation of BFSI companies in our sample is up 14.3 per cent since March this year as against a 22.3 per cent rise in the market capitalisation of non-BFSI companies.

Similarly, BFSI market capitalisation is up 60 per cent since the end of March 2023 compared to 83.3 per cent rise in non-BFSI companies during the period.

BFSI companies in our sample had a combined market capitalisation of Rs 95.4 trillion on Wednesday, up from the Rs 83.5 trillion at the end of March this year and Rs 59.6 trillion at the end of March 2023.

For comparison, the combined market capitalisation of non-BFSI companies increased to Rs 342 trillion on Wednesday from Rs 279.6 trillion at the end of March 2024 and Rs 186.5 trillion at the end of March 2023.

The combined net profits of BFSI companies are up 194 per cent since FY21 compared to a 102 per cent rise in their market capitalisation in the period.

Similarly, their net worth is up 68.5 per cent since March 2021.

In comparison, non-BFSI companies’ combined earnings are up 99 per cent since the end of FY21 against a 132 per cent rise in their market capitalisation in the period.

Non-BFSI companies also lagged behind in terms of capital growth and their net worth is up only 39 per cent since March 2021.

Analysts, however, say equity markets are forward-looking and investors expect significant earnings challenges for BFSI companies.

“The current level of earnings in banking is not sustainable because a significant part of it came from exceptional gains such as the write-back of bad loans rather than core operations.

"These gains would reverse as the cost of lending is now rising and bad loans are growing in retail segments, which has been the key growth driver for the industry in recent years,” said Dhananjay Sinha, co-head research and institutional equity Systematix Institutional Equity.

According to him, lending is now an undifferentiated business with shrinking margins and heightened competition and digitisation.

This has made non-BFSI companies in sectors such as automotive, defence and industrials favourites with investors at a time when domestic and foreign capital inflows in the equity market remain strong and the world’s major central banks are cutting interest rates.