December 2, 2020

ICICI Bank: Out Of The Dumpster Fire – Quality Bank For Cheap (NYSE:IBN)

Investment Thesis:

ICICI Bank (IBN) has historically been regarded as a “mediocre” bank compared to its peer HDFC Bank (HDB). Since its founding in 1994, the bank has struggled with poor underwriting, a boom and bust growth strategy, and poorly timed equity raises tied to execution issues. All in all, this has led ICICI to trade at a significant discount to HDFC on a P/BV basis as seen below:

Data by YCharts

Historically, much of this discount was warranted, but several recent developments have made me bullish on the stock. Ever since ICICI installed its new CEO in late 2018, the company has made several key improvements. For one, ICICI has now driven strong CASA deposit growth which has several benefits, namely a lower cost of funds. This will help drive a superior NIM profile moving forward. Furthermore, there is a drive towards credit quality and sustainable growth that should reduce volatility in this name. As seen in the chart below from a recent company presentation, the company is slowly growing the overall mix of lower risk rated loans while decreasing the higher risk rated loans.

Much of this is due to a shift toward retail loan vs domestic corporate loan that have lower default rates. Additionally, the company is reducing overall borrower concentration with the top 10 borrowers now making up 12% of the book in 2020 vs 14% back in 2018. This diversification will help reduce single name risk within the company’s portfolio.

On the liquidity front, even in the midst of the crisis and due to the recent capital raise, the company is well capitalized with the liquidity coverage ratio hitting close to 150% in June. The company also has strong profit margins as illustrated below. This helps illustrate the strong operating leverage that should allow the company to endure through this crisis.

ChartData by YCharts

Source: ICICI Investor Presentation

From a financial performance perspective, the company has been able to turn around and demonstrate strong revenue and profitability growth as illustrated below. I believe that this is just the beginning for ICICI and the company should ultimately become known as one of the better run Indian banks alongside HDFC Bank.

Source: ICICI Investor Presentation

Finally, ICICI still operates in a large and underpenetrated Indian market. Although 80% of Indians now have bank accounts, nearly half remain unused. Digitization is also still early with the vast majority of Indians still without credit cards. Thus, there is still a large greenfield opportunity for ICICI to grow organically in this market whether it is through lending or through adjacencies such as insurance or securities tradiing.

Risks

There are several key risks that are worth highlighting. First and foremost is COVID related disruptions. There is a loan moratorium going on in India right now and the long term impacts to the company in terms of the bad loan book is still TBD.

Net interest margins at the end of the day are still heavily influenced by central bank actions as well as the cost of deposits. A reduction in NIM will negatively impact the company’s revenue growth.

ICICI has had a rocky past in terms of credit quality, but there is definite improvement here. However, a future decline in credit quality will negatively impact the stock.

Valuation

Overall, I believe that a P/B of ~3.5x (similar to HDFC Bank) is fair given the strong liquidity and improving core metrics that the company has demonstrated. This puts my price target at ~$18/share or ~80% upside.

Conclusion

This is a bank that has had its struggles historically, but I believe that the company has finally turned a corner with strong deposit growth and a better credit culture. Furthermore, the valuation is undemanding and with 80% upside, there is significant upside for investors at this level. I recommend a buy at these levels.

Disclosure: I am/we are long IBN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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