ICICI Q2 show is solid, but should investors bet on it after a huge rally in the last 12 months?

-Robust growth in domestic retail loans, margins expand
– Asset quality improves further, provision coverage rises
– Credit cost to decline sharply aiding earnings normalisation in FY20
– Valuations compelling; re-rating to continue

ICICI Bank posted a net profit of Rs 655 crore in the second quarter of FY20 compared to Rs 909 crore in the same quarter last year. The bottom line number, however, was adversely impacted by a one-off adjustment. After the changes in the corporate tax rate, ICICI Bank decided to exercise the option of the lower marginal tax rate of 25.2 percent. Accordingly, the accumulated deferred tax asset (DTA) has been re-measured resulting in a one-time additional charge of Rs 2,920 crore in the standalone financial results. Excluding this, standalone net profit would have been higher at Rs 3,575 crore.

Overall, ICICI Bank reported a very healthy performance with core pre-provision operating profit (excluding treasury income) increasing by 24 percent year-on-year (YoY) driven by healthy loan growth, improved margins and lower slippages to non-performing assets (GNPA).

The stock has gained around 48 percent in the last one year and has been one of the best performing stocks in the Nifty index despite widespread concerns in the financial sector. Following such huge outperformance, the big question is – can the rally in ICICI Bank’s stock sustain? We believe so.

ICICI Bank has been a tough stock for investors in the past 10 years. The bank faced two asset quality cycles in the last decade. First, some of its retail loans turned bad in the cycle starting FY08 coinciding with the global financial crisis, and then came a corporate bad loan cycle, which has been going on since FY13. The private lender’s profits declined by 26 percent CAGR over FY15-19, despite listing three subsidiaries and enjoying one-off treasury profits. The bank saw GNPAs rising to a peak of around 10 percent and credit cost climbing to over 300 bps between FY15-19.  But the good news is that after a prolonged period of asset quality problems, ICICI Bank is now emerging from a lost decade. Also, the appointment of Sandeep Bakhshi to lead the bank was a positive step that helped in allaying investors’ concerns around corporate governance.

While receding asset quality woes drove the stock performance in the last 12 months, the likely surge in earnings will drive future stock performance. But how will earnings growth revive? Future earnings growth will be aided by both revenue growth and falling provisions. In FY19, ICICI Bank made provisions of Rs 19,600 crore, around 3.7 percent of average loans and 90 percent of the core pre-provision operating profit. The management has guided for provisions to fall to around 1.2-1.3 percent of average advances in FY20. The sharp decline in provisions/credit costs will drive significant improvements in returns ratios which in turn should drive up the stock price.

But our enthusiasm for the bank is not just limited to falling credit costs. ICICI Bank has transitioned from a stressed bank to a growing lender. The bank has continued to improve its retail franchise – both assets and liabilities. Consequently, ICICI Bank’s balance sheet is now comparable to the best in class with its CASA (low cost current and savings) deposits at around 45 percent and retail loans at 62 percent of total deposits. It is the bank’s emergence as a strong retail franchise that makes us decisively positive on the stock.

Considering the multiple levers that will help drive a sustained improvement in RoE (return on equity), the bank’s valuation is extremely attractive. With the stock trading around 1.6 times FY21 estimated core lending book, the current valuation still offers room for further re-rating.

Key positives
Overall advances growth stood at 13 percent YoY as a healthy 16 percent growth in the domestic loan book was partially negated by a 13 percent contraction in international loans. A strong focus on retail lending has enabled ICICI Bank to grow its domestic loan book at a higher pace than the banking industry, despite the cyclical weakness in the large corporate segment. Retail assets grew by a solid 22 percent YoY while corporate loan growth was muted at 3 YoY.

Deposits growth was robust at 25 percent and was driven by 35 percent growth in term deposits. The CASA ratio dipped marginally to 46.7 percent as at end September as the growth in CASA deposits at 15 percent lagged the growth in term deposits. Still, the overall performance continues to be impressive.

The net interest margin (NIM) for the quarter improved to 3.64 percent from 3.33 a year ago mainly on the back of margin expansion in the domestic book to 3.92 percent while margin on the international book remained negligible.

Fee income growth was healthy at 16 percent driven by retail fees which constituted 74 percent of total fees.

Despite operating expenses increasing by 24 percent YoY in Q2, the cost-to-income ratio improved by 130 bps to 43.90 percent

The big positive in ICICI bank’s Q2 earnings was an improvement in its provision coverage ratio (PCR) to 76.1 percent (up 210 bps sequentially). Including technical write-offs, PCR stood at 85 percent as at end September, among the highest in the industry.This is ahead of the bank’s target to improve PCR to 70 percent by June 2020. Having already reached the target in FY19, provisions in FY20 will be only towards incremental slippages which are expected to be substantially lower than FY19.

Gross slippages to non-performing assets (NPA) was restricted to Rs 2,482 crore in Q2. Thanks to contained slippages and higher provisioning, net NPAs declined by 50 percent YoY. The net NPA ratio stood at 1.60 percent, a multi-quarter low.

The bank’s tier-1 capital adequacy ratio of 14.62 percent at September-end was well above the regulatory requirement. RBI, during the quarter, had reduced the risk weights on consumer credit, excluding credit card receivables, from 125 percent to 100 percent which positively impacted the bank’s capital ratio by 25 bps.

Key negatives
The bank’s disclosed pool of loans to corporate and SMEs rated BB and below (potential stress) inched up slightly to Rs 16,074 crore (equivalent to 2.6 percent of the loan book) from Rs 15,355 crore in Q1 due to ratings downgrades.

Other takeaways
he growth in payroll expenses is due to the addition of 16,000 employees over the last 12 months.

The performance of its subsidiary, ICICI Home Finance was a tad disappointing as it continued reporting losses in Q2 due to higher provisions on non-mortgage portfolio.

ICICI Bank’s total exposure to NBFCs and HFCs was about 5 percent and telecom exposure stood at 1.8 percent of total outstanding loans as on September 30, 2019.

ICICI Bank had bought a loan portfolio from Dewan Housing Finance which, according to the management, is performing fine. The collection for almost the entire portfolio has been taken over by the bank.

Credit cost in H1 FY20 stood at 2 percent of average advances. The management has guided for credit costs of 1.2-1.3 percent of average advances in FY20 and is banking on recovery and write-back of loans to Essar Steel which is undergoing resolution. If the same doesn’t materialise, credit cost will be 1.8-2 percent for FY20.

Valuation rerating to continue
In May last year, the management articulated its strategy to deliver consolidated RoE (return on equity) of 15 percent while improving NNPA to 1.5 percent and maintaining provision cover above 70 percent by June 2020. The Q2 earnings strengthens our belief that the bank is well on track to  achieve these targets.

With its 2020 vision in place, investors should expect much lower NPA formation and normalised credit costs in FY20, mid-teen loan growth, steady margins and a fast journey to reach a RoE of 15 percent. With a strong capital adequacy, we don’t see many constraints in delivering its targets.

With a potential improvement in return rations, the current valuation of ICICI’s core book at 1.6 times FY21 estimated P/BV looks compelling. In terms of relative valuations too, ICICI is trading at a significant discount to its closest lending peer, Axis Bank.  ICICI Bank is a consensus buy on the Street today and investors will be better off going by the Street’s collective wisdom.

Source: Moneycontrol

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