Why Buy ICICI Bank Now
I had earlier written about in early 2013 why investing in the Indian stock markets was a bad idea till the general elections were held in 2014. I had said that investing in India was going to be a fruitless exercise if not a money losing one. I have been proved right in the last one month, as the stock markets have gone down by ~10% while the Indian Rupee (INR) has depreciated by almost ~15% during this period. The factors have been both internal and external which have led to a sharp crash in most stocks. The 10% decline in the broad market indices hides the fact that many stocks have gone down by 70-80% in the last 5 years. It is only the IT and consumer goods sector which has held up the index while infrastructure, power, banking, government owned, mid-cap and small-cap stocks have been mauled. There is literally blood on Indian streets as most stocks are trading in low single digit P/Es with a book value much below one. One of the major risks I had cited was the elections that are going to be held in 2014. The currency has crashed and most market commentators and TV talking heads are full of doom and gloom these days. However, the silver lining is that high quality, blue chip companies can now be bought at extremely cheap valuations. ICICI Bank (IBN) is one such stock that I would recommend investors to buy at the current stock price. The stock is trading at a single digit P/E, despite showing a 20% plus growth in the most recent quarter. The company's long-term performance is even better as it grew its topline by 800% and its bottomline by 900% over the last decade. The company has a diversified business model and some tremendous assets which should lead to a sharp price appreciation on spinoffs. I estimate that the stock will show a 100% return as the Indian economy stabilizes. I have been pessimistic about the Indian stock market and valuations but now have become bullish on ICICI which is trading near its 52-week low.
What does ICICI Bank do?
ICICI Bank is the second largest private bank in India by market valuation (~$15 billion) with a large branch network spread across the length and breadth of the country. The company has a good management, a wide portfolio covering all major banking products, a highly visible and trusted brand and respected top management. The company took a beating during the Lehman crisis as bad retail loans led to a slowing of growth. However, the management has reinvented the strategy to become more conservative and this had led to good results in recent times. The company also is a leader in the insurance, private equity and investment banking. In fact, ICICI Bank is the only truly universal bank in India besides the government owned State Bank of India.
What has led ICICI Bank to fall to the current lows?
The major factor behind IBN's stock price fall is the macroeconomic concerns being faced by the Indian economy. I have written a lot about the dangers of investing in the Indian stock market given the massive governance deficit, all prevalent corruption, crony capitalism as well as the persistently high inflation. The catalyst for the stock market crash has been the news of Fed tapering which has led to the INR going into a free fall as foreign investors pull out money from the Indian stock and bond markets. India runs a high current account deficit of ~$90 billion which makes it highly susceptible to money outflows. The INR has gone down from Rs 60 to Rs 68 in a matter of a month.
Why you should buy ICICI Bank
1) Good Governance - The importance of good corporate governance in India cannot be understated given the highly corrupt system. ICICI Bank is a well run bank with a reputed top management. Though the bank was recently caught in small sting operation, ICICI bank has one of the best corporate governance practices in the country. The company has a majority FII ownership and the top management is professionally run. This is quite different than most Indian companies which are family run or part of some family conglomerate. The company's top management is well regarded and the ICICI CEO was called by the Indian government to discuss a solution to the current crisis.
2) ICICI Bank has become very cheap - ICICI Bank is trading at valuations seen during the Lehman crisis when the stock took a massive fall due to malicious rumors floating during that time. The company currently trades at a P/B of ~1.3x and a trailing P/E of ~8x. The stock also gives a decent dividend yield of ~2.4%.
3) Growth prospects of ICICI Bank remain good - Despite the hiccups being faced by the Indian economy, the medium and long-term prospects of the economy remain good. It takes a crisis for the Indian state to correct itself. I think this crisis will help the government accelerate economic reforms which will remove the structural impediments to growth. The Indian government passed some reforms in December 2012 but much more needs to be done. The Indian finance minister recently announced the clearing of infrastructure projects worth almost $25 billion and there are also indications that the fuel subsidies will be drastically reduced. The company grew by 19% in the last 5 years which was one of the slowest periods in the Indian economy in the post reform period. As the economy improves after the next general elections, the growth rate should improve and the company should show a 20% growth rate. With P/E in the single digits, I would estimate the company's PEG ratio to be 0.5x which is a great risk reward ratio in my view.
4) ICICI has tremendous assets - ICICI Bank is not only one of the largest retail banks in India but also has a leading position in the insurance, private equity, asset management and investment banking industry. ICICI Securities is one of the top brokerages in India while its JVs ICICI Prudential, ICICI Lombard are top companies in their respective domains. ICICI Ventures is one of the leading Private Equity firms in India. The company should get a big boost when its insurance arms are allowed to do an IPO in the Indian stock markets in the coming year or two.
5) Stock Price has taken an unnecessary pounding - ICICI Bank's stock has taken a massive pounding in 2013 and the stock is down by ~39% YTD. The stock is trading very near to its 52 week low of ~$25 due to a combination of INR depreciation and fall in the Indian stock value. I think that the stock price fall has been overdone and most of the risks are being discounted. It is a good time to buy the stock when the whole market is in a panic mode.
6) Rupee has probably bottomed out - After a tumultuous fall, the INR has probably bottomed out against the USD in my view. This is a great time to buy Indian assets cheaply in INR and ICICI Bank is a great investment. The Indian currency has fallen a great deal from Rs 40 during 2009 to Rs 68 now and I think that most of the decline has been done. As Indian exports become more competitive and imports much more expensive, the CAD should decrease and the currency should strengthen from its current value in the next couple of years. USA ADR investors will not only get the benefit of the stock appreciating in value but will also make money through INR appreciation.
7) Diversified Business Model - ICICI Bank has a strong diversified business model which is not dependent on one particular banking product. The company was able to offset a sharp decline in commercial loans with a strong growth in credit card and personal loan growth in the last quarter.
8) Leader in Insurance - The Company's two insurance JVs ICICI Prudential and ICICI Lombard are the leader in the life insurance and non-life insurance sector. India's insurance sector industry has seen a consolidation in recent times with many companies exiting the business due to high competition. ICICI will benefit from this consolidation being one of the largest players in both insurance sectors. The insurance regulator (IRDA) is set to allow stock listing of insurance companies in India. This will lead to a boost in ICICI's stock price as its insurance subsidiaries get listed on the public bourses.
9) Improving low cost deposits ratio - The Indian savings bank account generally earn 4% which is much lower than the consumer price inflation of 10%. Though RBI has deregulated the savings bank interest rates, the bigger banks such as HDFC, SBI, Punjab National Bank and ICICI Bank have not increased their rates as customers are generally sticky. The "CASA" ratio indicates the percentage of low cost deposits to the overall deposits of the bank. ICICI Bank has managed to improve its CASA ratio to ~43% from 41.9% in the last quarter. The bigger Indian banks are able to leverage their large distribution networks and brand name to garner a large percentage of low cost deposit giving them a big advantage over smaller banks in India.
Other Indian Bank Alternatives
The Indian banking sector has seen a stock carnage in the last 2-3 months with many banking stocks falling by more than 50% in the last 3 months. The PSU banking stocks have been hit particularly hard and many of the small Indian banks are trading for a P/B of as low as 0.2x with a dividend yield of greater than 10%. The private sector banks have declined less but they too have failed to escape the carnage. HDFC Bank (HDB) which is India's largest bank is also listed on the US stock markets. However, I am currently not bullish on this stock given its very high valuation with a P/B of >3.5x and P/E of >20x. The premium over other private banking stocks is too high even though HDFC has grown faster in recent times and has better margins. HDFC Bank and its parent HDFC are vulnerable in my view given their valuations. In fact HDFC saw a sharp 10% fall on August 27. I think ICICI Bank is probably the best bet in the Indian banking sector right now.
ICICI Bank Risks
Most of the risks to ICICI Bank stem from the Indian economy rather than from the company.
- Indian Economic Growth goes down further - The banking sector is highly leveraged to the growth of the general economy. The Indian economy is in a bad state right now with most of the infrastructure, power and real estate firms having trouble in meeting their debt and interest obligations. Some of the bigger firms such as Deccan Chronicle and Kingfisher Airlines have gone bankrupt leading to thousands of crores of rupees in bad debt. If the economy continues to deteriorate, we would see an increase in non-performing loans (NPAs) which could lead to losses for the banks. Even though private banks in India have better management, they will not be able to escape the general malaise of bankruptcies.
- Increased Competition due to new Banking Licenses - The Indian banking sector is highly regulated by the Indian Central Bank and the number of private banks is restricted. However, the Reserve Bank of India (RBI) is all set to announce licenses for some new banks. Currently Indian banks manage to get high NIMs (Net Interest Margins) as the competition in the sector is restricted. With the entry of new players, competition will increase putting pressure on the interest spreads. However, RBI has imposed stringent rules on the new banks and I don't think they will become a threat to the incumbent banks in the next 4-5 years.
Financials have shown a Tremendous Growth
a) Quarterly Results have been impressive - The company is growing extremely well despite the stock price travails. The company's net interest income grew by 19.6% in the current quarter driven by an increase in asset base; and improvement of 26 basis points in NIM to 3.26%. Total non-interest income grew even more sharply by 32% year on year. The company's total net profits grew by 25% year on year in F1Q14 and its ROA increased to 1.75% from 1.5%.
b) Long-Term Revenue and Earnings Growth has been pretty astounding - The company has grown its revenue and earnings exponentially over the last decade. While the company has grown its revenues by ~800% in the last 10 years, earnings have grown by almost 10x. The dividend payout ratio remains low at ~20% but still yields an impressive 2.5%. Private banks in India have low payout ratios as they require capital to meet their fast growing needs.
Normalized Valuation implies a 100-150% Stock Price Return
I expect that ICICI Bank will see its multiples normalize as the Indian economy returns to a stable state. Assuming a PEG ratio of 1x, the PT comes to $50 which implies a 100% return from the current stock price. While a 100% return looks quite big, investors should remember that the stock was trading at $50 in just the last year. The stock fall has been more due to external issues and once those go away, the stock should normalize at this price target.
The stock is currently trading at trailing P/E of just 8x while the average valuation over the last 5 years has remained in a range of 8-30x. Assuming the stock appreciates to the midpoint of this range implying a PE of 20x, the stock should appreciate by 150% from its current stock price to the $62.5 level.
The time to buy stocks is when there is blood on the streets. Look at any media outlet and you will remain in no doubt that there is blood on the Indian streets. The commentators and analysts are all becoming highly pessimistic about the Indian stock markets, while the Indian currency has gone into a tailspin. Buying high quality Indian stocks is a no brainer in my view. ICICI Bank is a great stock pick at the current moment of time. The bank has shown extremely good growth in a slow environment with a credit growth of ~20% and a 25% growth in net profits. Bad loans remain tightly controlled by an experienced top management that has successfully navigated the company from an even bigger crisis during 2008. The company has got some tremendous assets besides its core retail and commercial banking operations. The stock is trading cheaply at a low single digit P/E which was last seen during the Lehman crisis. ICICI Bank faces no material company level risks as most of the risks are macroeconomic in nature. Given the strengths, I have little doubt that ICICI Bank will give great returns in the long term. The current Indian crisis has given a golden opportunity to buy a great stock very cheaply. This is a classic Mr. Market's depression phase when he is selling blue chips for a song. I would highly recommend investors to start buying ICICI Bank as the company will give at least a 100% return as the Indian economy gets out of the crisis.
Additional disclosure: I own ICICI bank shares in India through MFs