The skies have cleared for ICICI Bank, making it an exciting yet relatively safe investment bet
We are recommending ICICI Bank (May 9 closing market price: Rs 382) as a tactical pick.
ICICI Bank has been a tough stock to crack for investors in the past 10 years. The bank faced two asset quality cycles in the last decade. The first was a jump in retail bad loans in FY08, coinciding with the global financial crisis, and then came a cascade of corporate bad loans, the effects of which have been felt since FY13.
But the good news is that after a prolonged period of asset quality problems, ICICI Bank is now emerging from a lost decade. While FY19 was a year of consolidation, ICICI Bank will be transitioning from a stressed bank to a growing bank over the next two years and that change will be reflected in its stock performance.
With bulk of problem assets already recognised till FY18, the slippages or gross additions to non-performing assets (NPAs) trended downward in FY19. However, our enthusiasm for the bank is not just limited to receding asset quality problems. There is more than a reason that makes us decisively positive on the stock.
The bank has continued to improve its retail franchise on both assets and liabilities. ICICI Bank’s balance sheet is now comparable to best-in-class and is the first reason for our optimism, with the bank’s CASA (low cost current and savings accounts) at 50 percent and retail loans at 60 percent of total loan book.
Adequate capitalisation is the second reason. In an environment where a large part of the lending system has been crippled because of a shortage of capital (public sector banks) and receding liquidity (NBFCs), ICICI Bank is well poised to leap ahead with more than adequate capital.
The third and most important reason for our optimism is a likely improvement in return ratios. With bad loans receding, provisions too will come down and the reported numbers will improve significantly from FY20. For FY19, credit cost, or provisions, was 3.7 percent of average loans and 90 percent of its core operating profit. The management has now guided at provisions of 20 percent of core operating profit, or about 1.2-1.3 percent of average advances on a normalised basis.
And last but not least, considering multiple levers that should help drive sustained improvement in its earnings, the bank’s valuation is extremely attractive. With the stock currently trading around 1.4 times FY21 estimated book, current valuations offers a high margin of safety and a favourable risk- reward play. In terms of relative valuation also, ICICI Bank is trading at a significant discount to its closest lending peer, Axis Bank.
In May last year, the management articulated its strategy to deliver consolidated return on equity (RoE) of 15 percent while improving net NPA to 1.5 percent and maintaining provision cover above 70 percent by June 2020.
With its 2020 vision in place, investors should expect much lower NPA formation and normalised credit cost in FY20, mid-teen loan growth, steady margin all of which will help the bank achieve an RoE of 15 percent rapidly. With a strong capital adequacy (Tier I capital ratio at 14.73 percent), we don’t see many constraints in delivering its targets.
In short, the skies have cleared for ICICI Bank, making it an exciting yet relatively safe investment bet.
For more research articles, visit our Moneycontrol Research pageDisclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed hereThe Great Diwali Discount!
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