Year-to-date, ICICI Bank (ICICIBC) has underperformed Axis bank (AXSB), down 7% vs +27%. We believe near term subdued earnings have been over-amplified in the current cheap valuation. However, if we shift the debate to value ICICIBC with added discounts to valuation and without any benefit of doubt on stressed assets, with AXSB as a benchmark, we see a 15% upside to CMP. Underlying metric on retail franchise continues to be robust. While we continue to like both, we prefer ICICIBC over AXSB.
Upside risk of 15%+ for
ICICI Bank: We start with the premise that Axis Bank’s assessment of its watchlist (3.7% of exposure) is accurate and therefore adjust the book value for 60% of assets turning NPL. Next we provision fully for the incremental stress, i.e. 100% of the 60% of watchlist. We further gross up the PPOP for 9MFY17e earnings along with the contingent provisions to arrive at the net book value for FY17e.
This implies a valuation of 2.8x FY17E adj. BV at CMP. We now discount the P/B by 20% (cross cycle average of 12%) and apply this to the adj. BV for ICICI Bank excluding its subsidiaries for a ‘pure bank’ value of R220/sh, and along with R63/sh for subsidiaries, implying an upside of 16%.
To calculate the book value for ICICI Bank, we load up the watchlist with the Restructured book and Security Receipts and remove the SDR exposure for double counting and apply similar delinquency as that of Axis Bank. This implies stressed assets of 5.1% of exposure. We have also assumed R31 bn post-tax gain from potential IPO of ICICI Life and Rs 28 bn of contingent provision. To put it differently, a 0% upside for ICICI Bank at CMP implies 80% of the stressed assets turning NPL, a stretch in our opinion. However, a lack of credit cost guidance is sentiment negative.
On its part, Axis Bank disclosed total stressed exposure of R228.6 bn with a broad guidance of 60% of these slipping by FY18, but bulk of that upfronted in H1FY17. Further, the bank has guided for a 125-150bps of credit cost (on net customer assets) for the year. Against this, ICICI Bank disclosed a watchlist of assets which are below investment grade across few sectors, with no guidance of either anticipated delinquency or credit cost. As a result, new NPL and credit cost assumptions vary wildly across the Street. The June quarter earnings for ICICI Bank presented another challenge for analysts—the domestic and overall NIM collapsed 40bps and 20bps, respectively, on the back of 8.3% slippage ratio. This is feeding into a fear of another NIM decline as the bank recognises chunky NPL in September quarter. While the management is not dismissive of the impact, they believe that some cash accruals from earlier NPLs may cushion the NIM impact. The jury is out on that.
But the retail franchise remains robust: ICICI Bank is undergoing a course correction (again!!) and shrinking both the corporate/international book as well as UK/Canada subsidiaries. Share of retail loans for ICICI Bank is up 340bp y-o-y versus 100bp for AXSB. On the other hand, the funding profile for ICICI Bank is relying lesser on market borrowings and replacing that with both term-deposits and CASA versus Axis Bank, where the share of market borrowings have increased vis-a-vis last year.
Risks to our call: (i) A sharp deterioration in NIM as a result of larger than assumed delinquency could result in pronounced subdued PPOP growth, and (ii) failure to conduct the IPO of ICICI Prudential Life or a lower valuation could lessen PPOP growth.
Stressed exposure calculation overcompensating for ICICIBC : We start with the premise that Axis Bank’s assessment of its watchlist is accurate. As ICICI Bank management has been rather reticent, we do not give any benefit of doubt to its various stressed list, and end up aggregating the Restructured assets and Security Receipts. We however reduce the SDR exposure, as most of that is either restructured or an NPA.
Net income for FY17e post delinquency and provision assumptions: Next, we calculate the implied earnings buffer till FY17e for both Axis and ICICI Bank. We have relied on the core PPOP estimate (excludes trading and one time gain on sale of investments) based on our current model estimates. To that, we add back the contingent buffer created by the banks. For ICICI Bank, we add the gain on sale (IPO) for 12.65% of ICICI Prudential Life, where we value the subsidiary at R325 bn (based on last deal value).
Net adjusted book value calculation: Following this we calculate the net adjusted book value per share of the bank but adding the net income for 9MFY17e to the opening common equity and reducing the Net NPL. For ICICI Bank, we also remove the net equity investment in the subsidiaries.
Valuation and Upside risk to CMP 15%+ for ICICI Bank: On our FY17e adj. BVPS, Axis Bank trades at 2.7x. We discount the multiple by 20% (cross cycle discount is 12%) for ICICI Bank, and including the subsidiary valuation of R63/sh, we conclude that the upside to ICICI Bank is 16%.