ICICI's growth & value offer

Stripping off the value embedded in its subsidiaries, ICICI Bank is available atleast 40 per cent cheaper than its closest private rival HDFC Bank .

India's largest private sector bank is finally here with another mega share offering. With a market-capitalisation of Rs 81,000 crore, the highest among listed banks, ICICI Bank is planning to raise Rs 8750 crore with an option to accept an additional Rs 1300 crore in the domestic market.

Simultaneously, the bank would also raise a similar amount in the international market through issue of American Depository Shares (ADS) taking the total money garnered to nearly a quarter of its current market value. The money collected will go as essential capital to fund its rapidly growing assets and adhere to the new banking regulations.

Coming a week after a similar sized issue from real estate developer DLF got a lukewarm response from investors, investment banking sources suggest that several global investors abstained from the DLF offer considering a relatively more attractive deal from ICICI Bank.

Whatever be the response to this issue, ICICI Bank appears to be a long term story with an aggressive growth strategy that would now focus on the country's poor on the one end and overseas operations on the other, apart from the traditional segments like urban retail and corporate banking. Over the next two years, the bank should be able to achieve an asset growth of 28 per cent and profits some 35 per cent, according to analysts' estimates.

Despite the accelerated growth if anyone is complaining it is because ICICI Bank has been knocking at the capital market more often than its peers thus earnings a lower return on equity (ROE). Much to the dismay of analysts, ICICI Bank raised roughly Rs 10, 000 crore over the past three years.

Being in a business which requires money to make money, not all of the additional capital were to further its core business. A significant part went into feeding its babies, particularly the insurance subsidiary. According to analyst estimates, the additional capital committed towards its subsidiaries and the increased capital requirement (risk weights) for certain assets are roughly 50 per cent of the capital raised. But this is set to change.

Since its insurance and asset management businesses have grown big enough to stand up on their own feet, the bank is bundling them into a separate subsidiary ICICI Financial Services. Housing ICICI Prudential Life Insurance company (where it holds 74 per cent stake), ICICI Lombard General insurance (74 per cent) and ICICI Prudential Mutual Fund (51 per cent), this company would take care of their future funding needs.

"The money raised by the bank would be used to fund the capital requirements of the bank and not of the subsidiaries", says Vishaka Mulye, group CFO of the bank.

ICICI Bank intends to hold 94 per cent in the new subsidiary and has got definitive offers from various investors for a six per cent stake for Rs 2650 crore. And here is the clincher: the deal spells an implied valuation of Rs 44,600 crore for the holding company, or more than half its current market value.

On the face of it, ICICI Bank seems to reflect the characteristics of both a value and a growth stock, considering the embedded value in its holding company and its own growth potential.

The pertinent question is whether ICICI Financial Services' current valuations would be sustained when the company goes for listing about 12-24 months from now. Otherwise, investors may not realise the value made out to be built into the stock. 
 

FINANCIAL INDICATORS
Rs crore	FY05	FY06	FY07	CAGR  (FY05- FY07)	FY08E	FY09E	CAGR  (FY07- FY09E)
Total business	191224	311246	426376	49.32	567100	722900	30.2
Advances	91405	146163	195866	46.38	255950	324600	28.7
Deposits	99819	165083	230510	51.96	311150	398300	31.5
Net interest income	3208	4709	6636	43.83	9655	12000	34.5
Other income	3139	4181	5929	37.43	8800	10775	34.8
Operating profit	2679	3888	5874	48.07	10000	12350	45
Net profit	2005	2540	3110	24.54	4645	5700	35.4
E-Analysts Estimates

The value within
No doubt, the subsidiaries are in fast growing businesses and enjoy leadership in their respective segments. While general insurance market has been growing at 25 per cent, life insurance market is almost doubling every year. Also Indian mutual fund industry has been growing at 30 per cent per annum over the last couple of years.

While ICICI Prudential Life Insurance and ICICI Lombard General insurance are market leaders among private players in the respective segments with a market share of 28 per cent and 34 per cent respectively, Prudential ICICI Asset Management is among the top three players with assets of over Rs 50,000 crore. Last year, the premium income in both life and general insurance grew at 98 per cent and 89 per cent year-on-year respectively.

Assigning the best valuation of about eight per cent of net asset value for Prudential ICICI Asset Management, the value works out to approximately Rs 2000 crore or Rs 18 per share of ICICI Bank. Similarly, analysts estimates the value of the general insurance business at Rs 35 per share applying an earnings multiple of 15 on next year earnings, assuming a 75 per cent earnings growth.
 

VALUATION
	CMP  (Rs)	P/BV (FY08E)	P/BV (FY09E)
ICICI bank	835-900*	2.1-2.2#	1.9-2#
HDFC bank	1105	4.8	3.9
SBI	1323	1.5	1.3
* For retail investors # P/BV (banking)

The value of the life insurance business however is estimated by analysts at not more than $5-7 billion. Putting all this together, and the value of ICICI Venture Capital and ICICI Bank UK, which are not part of the holding company, and the value of its non-strategic stakes like in NSE, MCDEX, 3i Infotech and Firstsource Solutions, the fair value estimate for ICICI Financial Services averages over Rs 250 and Rs 330 for the coming year and the next.

This means that, the bank is available for a market-cap of less than Rs 60,000 crore, based on a conservative estimate. Though there are certain concerns on ICICI bank's quality of earnings compared to say HDFC Bank, given the growth potential in its core business, the valuation seems justifiable with good scope for appreciation. 

Hinterland to foreign soil
With a strong franchise, the parent bank has its growth drivers firmly in place. Offering a wide range of products from credit card to mortgages, the bank is a clear market leader in the retail segment, which constitutes about 65 per cent of its loans.

While the retail market has grown in the range of 30-40 per cent over the last three years, ICICI Bank has consistently beaten the industry with a 60 per cent growth each in 2004-05 and 2005-06, and 39 per cent in the last fiscal, a slowdown mainly due to fluctuation in interest rates.

The retail market is expected to grow at 20-25 per cent in next few years and going by the past track record ICICI Bank should outpace the industry growth rate. Brushing aside the rising interest rate impact on loans, Kalpana Morparia, Joint Managing Director, said that the bank expects to grow its retail business profitably.

After making its presence felt in the urban retail segment, the bank is turning to opportunities in the rural sector. Though the urban retail segment will continue to be the bank's growth engine, ICICI Bank wants to reach the consumers in the hinterland, not serviced by banks currently.

"We feel that if properly serviced, rural areas can offer greater opportunities than even retail," says Mulye. To grab this opportunity, the bank has formed a multi-product and multi-channel strategy primarily by partnering with various micro-finance organisation, self-help groups and even corporate targeting the retail as well the SME customers.

Also, looking at the big volumes of cross border M&As, growing aspiration of Indian companies to have a global size and to meet the needs of the NRI population, the company is looking forward to enhance its international presence. Currently, the bank has the largest international business among Indian banks with presence in 18 countries outside India.

Currently, this forms 19 per cent of its total consolidated balance sheet. Going forward, the bank will also focus on the international retail i.e. fees and liability (deposits) generation business. It already has a 25 per cent market share in inward remittance market of $28-30 billion.

Returns -- low or high?
The bank's profitability ratios have been declining gradually since FY2004 owing to a host of reasons. While intense competition in retail lending has meant that the bank has to constantly offer best (lower) rates to maintain or gain market-share, a deterioration in retail asset quality too has increased the cost of credit. Besides, the bank's cost of funds is higher and it only got worse during the past couple of quarters when there was liquidity squeeze in the market.

While its net interest margins (NIMs) are fluctuating and lower than competitors due its higher cost of funds, return on assets have been declining due to rising credit and operational costs. Though the latter is true for every other bank, ICICI Bank has been particularly hit.

According to Morgan Stanley, between FY2004-FY2007 ICICI Bank's return on risk-weighted assets dropped from 1.8 per cent to 1.2 per cent while the same metric for HDFC Bank declined from 1.9 per cent to 1.6 per cent, signalling a significant gap in profitability.

PEER COMPARISION
	NIM (%)			Return on Equity (ROE)			Return on Assets (ROA)
	FY05	FY06	FY07	FY05	FY06	FY07	FY05	FY06	FY07
ICICI Bank	2.76	2.74	2.57	17.90	16.40	13.40	1.50	1.30	1.10
HDFC Bank	4.00	4.00	4.50	18.50	17.70	19.50	1.40	1.40	1.40
SBI	3.40	3.40	3.30	19.40	15.90	16.00	0.90	0.80	0.90

More importantly, the bank's ROE, which is a function of ROA and leverage, has been depressed since it has raised capital more often. Since the bank will have excess capital for the next two years, its ROE would continue to suffer. Analysts expect the bank to report an average ROE of 13 per cent till 2011, roughly the time period for which the additional capital is estimated to last.

Going forward things would change. While the bank would not be forced to raise high cost funds from the market after this public issue, its proportion of low cost deposits (CASA) would also go up with expansion in branch network, especially after its latest acquisition Sangli Bank comes under its fold.

In the longer term, things could be even better when a structural shift happens in its portfolio with a greater proportion of rural and international business. While the rural business would bring in low cost deposits, the international business can be profitable because of low cost of servicing.

"Even though the servicing cost and delinquencies would be higher on the rural portfolio, it can be offset by a higher interest rates chargeable on borrowings," says Mulye.

In FY07, while net interest income grew 41 per cent and other income grew 39 per cent to Rs 6,636 crore and Rs 5914 crore respectively, operating profit jumped by 51 per cent to Rs 5,874 crore.

However net interest margins contracted by eight basis points to 2.66 per cent due to cost push. Net profit grew only 21 per cent to Rs 3109 crore due to higher provisioning requirements on the retail portfolio.

At the price band of Rs 835-900 for retail investors (Rs 50 per share less than the actual price band of Rs 885-950), the bank is available at 2.1-2.2 times and 1.9-2 times its earnings for FY08E and FY09E respectively, excluding the value of its subsidiaries.

Closest private peer HDFC Bank trades at 4.8 times and 3.9 times for the same period. Valuations thus seems attractive. Moreover, though HDFC bank's quality of earnings is much better, ICICI bank seems to be more than compensating for it by way of faster growth.

Going by the past record, whenever the bank has raised capital its price performance has been poor for next six months. But ICICI Bank is a stock for the long haul, and gains could be substantial when the holding company goes for listing.