ICICI Bank

Shareholders can stay invested in the ICICI Bank stock, as it trades at compelling valuations. Exaggerated concerns about the bank’s financial troubles, rumours of promoter stake sales (which have been proved wrong) and its exposure to troubled assets (doubtful assets have been provided for) have depressed valuations.

At the current market price of Rs 411, the ICICI Bank stock trades below (0.94 times) its September book value and 11 times its trailing one-year earnings. Its peers — Axis Bank and HDFC Bank — trade at 12 times and 18.8 times respectively.

At its peak in January, the stock commanded a PEM of 36 and was trading at 3.6 times book value. Though further downside in the stock cannot be ruled out given the challenges to earnings growth over the next one year, prospects over a two-three year time-frame seem brighter. Investors can consider accumulating the stock on declines.

The bank has significant scope to expand corporate lending and step up fee income. As it consciously slows down retail lending and reduces costs by restructuring its deposit base, the risks associated with its operations may moderate.

Business mix

ICICI Bank’s advances book is dominated by retail advances (55 per cent of total advances), followed by overseas advances (26 per cent), corporate advances (9 per cent), SME (3 per cent) and rural (6 per cent).

The bank has already discontinued small ticket personal loans and is going slow on other unsecured retail advances.

The corporate and SME advances portfolio of the bank is small vis-a-vis its peers. The focus on this segment can drive growth without compromising on asset quality.

Housing loans make up 28 per cent of total advances for the bank. Provisions relating to investments and defaults have been a key drag on the bank’s valuations in recent months. In this respect, ICICI Bank’s gross NPA/advance of 4.18 per cent, as of September, is among the highest in the sector. But provision coverage of 52 per cent helped it to contain net NPAs at 1.9 per cent. About 57 per cent of net NPA pertains to unsecured products, which remains a concern. In the coming quarters, write-backs in the gilts portfolio, may also reduce the provisioning requirements and bolster profits. However, the bank is well placed on capital adequacy, with the ratio at 14 per cent; reducing the need for raising capital in the near future.
Standalone Financials

After growing aggressively to capture market share, ICICI Bank has recently witnessed a significant slowdown. From 2004-2008, the bank’s advances grew at 40 per cent compounded annually, while profits grew at 26 per cent. But provisioning towards NPAs and investments have weighed on profit growth over the past two quarters.

In the first half of 2008-09, net interest income (NII) grew at 30 per cent, driven mainly by margins improving from 2.2 per cent to 2.4 per cent.

This was driven partially by the hike in lending rates in the September quarter, as also a lower cost of deposits. Going forward, NIMs may moderate, following the recent 1.5 per cent home loan rate cut and likely lending rate cuts, which the bank is expected to undertake in the near future. The bank’s efforts to curtail high-cost wholesale deposits may offset the impact of lower rates on NIMs to some extent. In the first half, the bank retired bulk deposits worth Rs 24,000 crore and improved its low-cost deposits ratio to 30 per cent.

It also made considerable progress in reducing operating costs with the cost-income ratio falling sharply from 52 per cent to 47 per cent in the first half. Fee income may be another key growth driver.

In the first six months of FY-09, non-interest income chipped in as much as 45 per cent of ICICI Bank’s net revenues, despite a massive treasury loss of Rs 747 crore. As ICICI Bank remains a leading distributor of third party products, even a moderate recovery in the investment markets over a two-three year time-frame, may drive fee income growth. A large branch network may give ICICI Bank an edge over competitors in this context.
Subsidiaries

Concerns about the bank’s exposure to toxic assets in overseas subsidiaries have also been a matter of concern. However, after taking a loss in its UK subsidiary and making additional provisions from its reserves for the entire sub-prime exposure, further risks from source appear unlikely. The Canada subsidiary (profits of CAD 21 million in the first half), focuses mainly on India-related investments.

A sharp improvement in earnings from the other subsidiaries (ICICI AMC, Ventures and Securities) or unlocking of value from a listing of these subsidiaries appears unlikely for now.
Outlook

Shareholders of ICICI Bank may require a three-year horizon to reap the full rewards of their investment. Steps initiated by the bank to reorient its focus — going slow on risky advances and stepping up exposure to corporates — may take time to pay off.

The next one year will be challenging for the bank, as further asset quality slippages and subdued earnings (on the back of slower advances growth and lower NIMs) cannot be ruled out.

The heightened risk perception relating to the bank may also peg up costs and could force the bank to raise capital at a stiff cost.

However, on the positive side, ICICI Bank may be one of the key beneficiaries of the recent RBI measures — the CRR reductions, interest rate cuts and more liberal provisioning and capital adequacy norms.

The bank’s housing finance company will also benefit from the recent RBI move of classifying the HFC loans also as priority lending sector.