ICICI Bank's Stock Is Best Left Alone

| About: ICICI Bank (IBN)

ICICI Bank's (NYSE:IBN) stock price has seen constant declines since the middle of 2008. Recent hammering of the stock had taken the share price below its Book Value, but it has now recovered to just a tad over Book Value (1.25x). Let's examine whether there are some good reasons for the drastic declines.

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Strong Capital Base

A strong capital base is the number one issue to consider before investing in a lender.

ICICI Bank has its Capital Adequacy ratios at 13.46 percent much above the mandatory 9% requirement stipulated by RBI. However Gross and Net NPA (Non-Performing Assets) at 3 percent and 1.39 percent is among the highest in the industry, which is a cause for concern. What is more disconcerting is the sharply declining trend over the last 3 years. Consider how sharply Provisioning Coverage (Provisioning expense/Gross NPAs) has been reduced to just over 50% of Gross NPAs - that's a cause for bigger concern, perhaps.

Return on Equity (RoE) and Return on Assets (RoA)

These metrics are the de facto standards for gauging bank profitability. Generally investors should look for mid to high-teen returns on equity. It is easy to boost bank's earnings in the short term by under-provisioning or leveraging up the balance sheet, which can be unduly risky over the long term. For this reason, it is good to see a high level of return on assets as well. For Banks a top RoA is in the 1.2 to 1.4 percent range.

ICICI Bank has shown a drastic falling margins trend, with FY08 consolidated net margins standing at a poor 5.2 percent down from about 6.4 percent a year ago. This is the main reason behind deteriorating RoA and RoE ratios, which also display the consistently declining trend. Return on Equity figures show a dismal 7.63 percent and RoA too is poor at 0.71 percent.

Compare this with the other leading private sector bank HDFC Bank, with RoE at over 16 percent and RoA at 1.42 percent. To be fair though, ICICI has had consistently higher Asset Turnover ratios than the State Bank of India, Axis Bank and even HDFC Bank - but that obviously cannot compensate for the abysmal net margin levels. This tells the story perhaps, of how things have gone wrong with the aggressive growth strategy pursued by ICICI Group.

Efficiency Ratio

The efficiency ratio or cost to income ratio, measures non-interest expense, or operating costs, as a percentage of income. Basically it tells you how efficiently the bank is managed. Many good banks have efficiency ratios under 55% (the lower the better).

It has been generally maintaining cost-efficiency ratios at just over 50 percent, which is okay in isolation perhaps. However, it pales in comparison to some stellar records of other private banks like Yes Bank (29.50%) and Axis Bank (37.75%), and even the PSU State Bank of India (36.65%)

Net Interest Margins (NIM)

Another simple measure to watch is net interest margin, which looks at net interest income as a percentage of average earning assets. Track margins over time to get a feel for the trend.

Net Interest Margins are also showing a gradual declining trend with FY08 NIM standing at 2.22%. You can put this in perspective when you compare it with
HDFC Bank net interest margins
at over 4% for the last few years and the gradually improving trend!

Strong Revenues

Historically many of the best-performing bank investments have been those that have proven capable of above-average revenue growth.

ICICI Bank (Group) has pursued growth aggressively and this shows in the overall growth track record of over 44 percent CAGR over 5 years. Interest Income and Fee Income have grown apace at around 40%. However this has come at a cost - declining margins and a severe squeeze on profitability.

Price to Book

Because a bank’s balance sheets consist mostly of financial assets with varying degrees of liquidity, book value is a good proxy for the value of a banking stock. Also many of the assets included in their book value are marked-to-market –in other words they are revalued every quarter to reflect shifts in the marketplace, which means that book value is reasonably current. So the base value for a bank should be the book value. Any premium over that, investors are paying for future growth and excess earnings. Typically big reputed banks trade at 2x to 4x book value.

ICICI Bank is currently (as of March 27, 2009) trading at just a tad over Book Value (1.25x), historically at its lowest levels in the last 5 years. Similarly, on a price-to-earnings measure it is quoting at ~10x TTM earnings; again, historically the lowest levels in 5 years.

However the 5 year track record on some very important metrics (for bank stocks) makes it clear that the stock is best left alone; we now know there are good reasons why the stock has been so badly hammered in the recent past.

Overall verdict

Unworthy of further investigation. Too risky - better left alone.

Disclosure: no positions