We are increasingly concerned that the earnings profile could be a source of disappointment over the next few quarters/years as we believe the best of earnings is behind us.
We expect earnings CAGR of 11% over FY2014-16 and RoE (adjusted) of 14%. There is limited scope for NIM expansion (currently 3.3% with domestic NIM 3.7%) while slower loan growth (15% CAGR over FY2014-16e) is likely to put pressure on revenue growth. Credit cost, currently at 80 bps, is likely to increase to 110 bps over FY2014-15, implying a subdued earnings profile.
Disappointing quarters ahead
We are less inclined to take a risk from hereon as price performance could increasingly depend on valuation expansion compared to earnings upgrades. We value the bank at 1.9X book and 14X EPS (12 months forward). Despite concerns about business, ICICI Bank has done exceedingly well compared with its peers.
We would use the current opportunity to exit.
A key risk to our recommendation would be possible redressal of bottlenecks in infrastructure, which could result in substantially lower credit costs and an early revival of the investment cycle, leading to better growth opportunity. Visibility on both these issues could result in expansion in multiples in the first stage followed by earnings upgrades. We feel there could be disappointment on both these issues.
New regulations imply higher cost of running
The cost or the capital required to operate a bank in the current regulatory framework, especially domestic-systemically important banks (D-SIB), has increased. Core Tier-1 ratio of 8%, non-equity Tier-1 instruments of 1.5%, counter-cyclical buffer of 0-2.5% and D-SIB of 0-1% implies banks like ICICI Bank would need to operate with more than 11% as Tier-1 capital. This is in sharp contrast to 8-9% core equity under Basel-2, which implies banks would deliver lower sustainable RoEs (return on equities) than they did in the past.
Business headwinds to keep valuations at bay
Over the past two years, there has been increased confidence in the way ICICI Bank has been building its business, which has led to its outperformance compared with its peers (i) a cautious mindset to growth given the economic conditions with lack of focus on market share, (ii) visible reduction in risk across various products (international, CDS-credit default swaps), (iii) a conscious approach to better pricing of its loan products and (iv) gradual improvement in the liability profile. Despite concerns about its corporate portfolio the bank has done well compared with HDFC Bank over the past one/two years.
Importantly, a key qualitative factor driving our outlook has been the managements focus on achieving its deliverables. The management has set high benchmarks and has been/will be able to achieve them in well defined timeframes. However, we feel the ability to sustain the current performance would be a challenging exercise and room for earnings disappointment has increased especially after a strong expansion in multiples.
ICICI Bank would see the dual impact of (i) slow revenue growth and (ii) high credit costs hurting earnings growth for the next few quarters until we see sustained improvement in the economy. We value ICICI Bank at R1,240/share. We expect the bank to deliver 11% CAGR (compound annual growth rate) in earnings over FY2014-16 and RoEs of 14% in this period.
Kotak Institutional Equities