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Home / Markets / Mark To Market /  How ICICI Bank has been narrowing the valuation gap with HDFC Bank

ICICI Bank Ltd’s shares have outperformed those of peers and the sector index in the past four months, and with good reason. A fast-healing corporate loan book and early provisioning against risks from the pandemic have cheered investors.

Most of all, the lender has reported a steady growth in operating profit in the last two financial years. While the bank has not been able to trump HDFC Bank in the valuation game so far, the private lender is well on its way in narrowing the gap with its rival. ICICI Bank shares have risen by 22% in the past four months, against an 8% increase in HDFC Bank’s share price.

ICICI Bank’s steady improvement in operating metrics against the backdrop of modest valuations has meant that its shares have been ripe for a re-rating
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ICICI Bank’s steady improvement in operating metrics against the backdrop of modest valuations has meant that its shares have been ripe for a re-rating

There are two key reasons behind this. One is the trouble surrounding HDFC Bank’s digital outages, which led to the lender being penalized by the regulator. In December, the Reserve Bank of India (RBI) barred the lender from issuing credit cards to new customers until it fixes its digital issues. This has been weighing on the bank’s shares and limiting gains since then.

Simultaneously, ICICI Bank’s steady improvement in operating metrics against the backdrop of modest valuations has meant that its shares have been ripe for a re-rating. Analysts at Jefferies India Pvt. Ltd point out that the lender may show more stabilized profitability metrics instead of the large volatility seen in the past years. “An improvement in velocity of ICICI’s operating profit growth & steady credit cost will bring down volatility in earnings, which has been a key reason for 55% discount in valuation versus HDFC Bank. Lower volatility can reduce beta and this itself can help bridge the gap in valuation by half," they wrote in a note on Tuesday.

Beta is the measure of an investment security’s volatility in returns relative to the entire market.

ICICI Bank’s operating profit growth has been volatile since FY17 after a sharp rise in bad loans necessitated an increase in provisioning. The lender’s corporate loan book has since then shown a decrease in slippages, even after the pandemic struck. Fresh stress has emerged from the retail and small business loan book. But against this, the lender has made adequate provisioning. Ergo, incremental provisioning needs are expected to be low and hence the bank may report healthy growth in quarterly profits and return on equity. “Their biggest drag was the corporate loan book delinquencies in the previous years. Now that book is expected to perform well and retail stress is not expected to get out of hand," said an analyst, requesting anonymity.

ICICI Bank shares trade at a multiple of 2.6 times its estimated book value for FY22, still modest compared with the multiple of 3.6 times for HDFC Bank. On the valuation front, there is still some distance left for ICICI Bank to cover, and some gap can be expected to remain given HDFC Bank’s far longer record of steady growth.

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