ICICI Bank has staged an amazing turnaround. Is it overvalued now?

When Sandeep Bakshi assumed the role of CEO in 2018, the bank was struggling with high NPAs. The outgoing CEO, Chanda Kochhar, was being investigated for misusing her position. But it’s amazing what a combination of good management and a good credit cycle can do.

- Gross Non-Performing Assets (GNPA) was 9.9% in March 2018. It’s 2.1% at the end of June quarter.

- Net profit was ₹3,363 crore in FY2019. It’s ₹42,299 crore on a TTM basis ending June quarter.

- Book value was ₹1.08 trillion. It’s ₹2.53 trillion at June quarter end. A CAGR of 16.7%

- Price was ₹400 in March 2019. It’s around ₹1,220 today. A CAGR of 23%

Fast forward to today, its PB trades at 34% premium to HDFC Bank and a small 1-2% premium to Kotak Mahindra Bank.

This implies ICICI Bank offers significantly better future prospects compared to HDFC Bank. But, this conclusion is worth questioning.

First, compare their book value per share (BVPS) growth. A better way to compare two banks is to look at BVPS growth rather than Earnings per share (EPS) growth. This is because provisioning expenses cause banks' earnings to vary. This can differ from bank to bank, which complicates comparisons. In contrast, Book Value exhibits greater consistency and is less susceptible to variations.

ICICI Bank has grown BVPS by 0.5% more than HDFC Bank in the last three fiscal years. Hardly a meaningful difference.

For more such in-depth analyses, read Profit Pulse

Of course, book value growth is just one important factor that drives valuations. What about asset quality?

Gross non-performing assets (GNPA) of ICICI Bank has improved from 5.3% to 2.1% between FY2021 end and June 2024 quarter. During this period, HDFC Bank's GNPA went from 1.3% to 1.2%.

Even after the HDFC Bank merger, it has better asset quality than ICICI Bank. It is also consistent across cycles. Can ICICI Bank's asset quality endure a downturn as well as HDFC did? Only time will tell.

Also Read: HDFC Bank: Will the elephant ever dance again?

If not recent BVPS growth or asset quality? What justifies this premium? What about Return on equity (ROE), an important indicator of a bank’s profitability.

Between FY21 and FY24 ROE of ICICI Bank has improved from around 12.8% to 18.8%. HDFC Bank's ROE declined marginally from 17.0% from 16.6% during the period.

ICICI Bank's high valuation may be due to its better ROE than HDFC Bank's over the last two years.

ICICI Bank was once undervalued compared to its peers. Now, it has "mean-reverted." HDFC Bank also mean-reverted but downwards.

For the first time in 15 years, they have swapped positions. But, this raises concerns about ICICI Bank's future returns. That’s because high valuations come with a high P/B ratio, which could be a problem.

Over the last five years, stock price returns were 23% CAGR. Two levers were driving these returns – book value per share (BVPS) growth and P/B re-rating. If we decompose this 23% return, we find that book value per share (BVPS) compounded at only 17.4%. So, the remaining around 7% over and above the BVPS growth came from P/B getting re-rated from 2.1 to 3.38. This “re-rating lever" is pretty much exhausted.

At 3.38, ICICI Banks’ P/B ratio is the highest amongst peers. It is above its 10-year median of 2.4. It is also at a 10-year high compared to last 10 years. So, future stock returns depend largely on BVPS growth.

The Goldilocks period for ICICI Bank is potentially over. A 20%+ return is only possible if BVPS can grow 20%+ and/or P/B multiple expands further from these high levels.

While not outside the realm of possibility, it is unlikely.

On the other hand, HDFC bank trades at 2.52x, a decadal low. Its asset quality is pristine. Challenges like deposit growth are near-term. This leaves more room for upside as they get addressed.

The "spread" in valuations between HDFC Bank and ICICI Bank is telling. Too much of a good thing can turn out to be bad for ICICI Bank and vice-versa for HDFC Bank.

 

Note: The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only.

Rahul Rao has been Investing since 2014. He has helped conduct financial literacy programs for over 1,50,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.

Disclosure: The writer or his dependants may or may not hold the stocks/commodities cryptos/any other asset discussed here.

(This story has been updated as the earlier version of this article used some numbers that were approximations of the exact numbers. This has now been rectified.)