ICICI Bank Stock Pick

Should you SELL ICICI Bank?

Sandeep Singh

Posted online: Monday , May 07, 2007 at 1441 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->

On April 28, Saturday, the board of directors of ICICI Bank, the country’s second-largest bank, approved raising Rs 20,000 crore of additional capital to bankroll growth over the next three years or so. Two days later, when the market opened, the ICICI stock slumped 8 per cent almost immediately, pulling down not just banking stocks, but the entire market.

Short-term pain, but…Here was one of India’s fastest-growing big businesses putting the first of the pieces in place that would give it a chance to double its size in two to three years, and yet the market, which has a healthy growth fixation, seemed to be disapproving. Here was one of India’s most-respected companies and a poster child of liberalised India nudging closer to unseat State Bank of India from the top spot in the banking sector, and the market was giving a thumbs down. What gives?
Maybe, the market was concerned about the tame profit growth the bank had logged in the last quarter of 2006-07, the results for which it had declared on the same day as the announcement of the capital-raising plans. Maybe, the market felt the 20-30 per cent dilution in equity and the corresponding drop in return on equity — a measure of how well a bank is using its capital — was more than it needed to do. Maybe, the market was doubting whether this big bank could grow bigger in a short period of time and whether the economic environment would facilitate that jump.
…long-term gainOf course, profit growth in the fourth quarter was tame, hit by rising interest rates and a conscious decision to slow down retail lending, particularly housing loans. But focussing on the micro details of a quarter of results would be to miss the big picture. The grand design can be summed up in one word: growth. Says Kamlesh Gandhi, country head - investment banking, Religare: “India doesn’t need many banks. It needs big banks, and ICICI aims to be one.” With this capital-raising exercise, ICICI is embarking on another phase of heady growth.
For every Rs 100 a bank gives out as loans or invests, it has to maintain Rs 9 as capital (equity, reserves and some categories of bonds); from 2008-09, this will increase to about 12 per cent. This is called the capital adequacy ratio (CAR). Conversely, it can give loans only to the extent of the capital it has. Because of the frenetic pace at which it has been growing - a compounded annual growth in assets of 40 per cent over the last three years — ICICI is operating close to that limit, with a CAR of 11.7 per cent as of 31 March 2007.
The capital infusion of Rs 20,000 crore will boost its tier-I CAR (comprising equity and reserves), which is currently set at 6.5 per cent of the overall 9 per cent CAR. According to an analyst, ICICI’s tier-I CAR will rise from 7.4 per cent to 13 per cent, easily funding its growth plans for the next two to three years. Says Ashutosh Narkar, banking analyst, India Infoline: “Most banks leverage their capital 14-15 times.” At 15 times, ICICI Bank will be able to lend Rs 300,000 crore. To put this figure in perspective, as on March 31, it had assets of Rs 344,658 crore. In other words, it is aiming to nearly double its balance sheet size.
On Friday, the ICICI stock closed at Rs 855. If its sells its stock at Rs 850 a share, its equity base will get diluted by 26.4 per cent; at Rs 800, by 28.1 per cent; at Rs 750, by 30 per cent. The market is fretting over this dilution. In the process, it is perhaps short-selling the medium-term expansion this dilution will facilitate. In the past three years, ICICI has diluted equity twice. On both occasions, the impressive earnings growth has compensated for the equity dilution (See graphic: Trading equity dilution for growth).
Risks and rewardsThe difference between then and now is that ICICI was about half its current size, which makes it more difficult to grow at that same pace. Although it is planning its domestic-cum-American Depository Share (ADS) issues in June, leveraging on that and growing its asset base will happen over two to three years.
Continuing demand for funds is critical for that scenario to pan out. Says Rakesh Jha, senior general manager, ICICI Bank: “Credit growth has fallen, but we expect it be 25 per cent for the sector.”
Analysts expect ICICI Bank to grow faster than that — at least 30 per cent a year for two to three years. Says Gandhi: “If we look at infrastructure investments in airports, ports, power and roads, the demand for funds is huge. In that context, ICICI’s move is strategically correct.”
If demand holds, the dip in RoE should be temporary. Post-dilution, the RoE will fall from 13.7 per cent to 11 per cent. Says Narkar: “If the bank manages to grow as in the past, it should attain a decent RoE level in a year’s time.” Adds Jha: “If we exclude our investment in the two insurance subsidiaries and include profits from our banking subsidiaries, the RoE increases to 15.5 per cent.”
ICICI is planning to spin off its subsidiaries to reduce the burden on the bank’s balance sheet, especially in the long-gestation insurance business. Says Jha: “Once the insurance business is spun off, it will free up the bank’s capital.” Branch expansion will also lead to more efficiency gains and reduce its cost of funds, something it has been trailing on. As on March 31, the bank had 755 branches. Recently, it acquired Sangli Bank, which will take that number up to 950. Says Jha: “More branches will increase our access to low-cost savings and zero-cost current account deposits.”
Several banks will tap the market in the coming years to keep up with CAR norms. ICICI has played its hand early, which might be a good thing, as it can avoid the bunching up and get valuations that might be as good as it gets — on its Friday close of Rs 855, it was trading at 29 times its trailing four quarter earnings. Says Narkar: “They are tapping the market early and will now not need capital for another three years.” If it manages to keep the juggernaut going, as most think it will, the payoff will be smart.

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