Undervalued

ICICI Bank and SBI are undervalued compared with their Asian peers

The State Bank of India scrip, even after its recent fall to Rs 595, is still a good 15 per cent higher than at the beginning of January, while the ICICI Bank scrip has gone nowhere during the month.

At its current level of Rs 595, the SBI stock quotes at a price-earnings ratio of 8.3 times annualised nine-monthly EPS, while ICICI Bank, at Rs 295, quotes at 11.5 times its annualised nine-monthly EPS.

Yet SBI's net NPAs were only 2.88 per cent as at end-December 2003, compared to ICICI Bank's 4.7 per cent, while restructured assets are almost double for ICICI Bank.

SBI's net interest margin is 2.87 per cent, compared with ICICI Bank's 1.8 per cent. ICICI Bank's legacy problems, although diminishing, have always been a source of concern.

Despite that, the market has always put a premium on the ICICI Bank scrip, believing that its private sector character deserved the premium.

In the past few months, however, the distance between the two has narrowed, thanks to a sharp rise in the State Bank stock, probably on the basis that its computerisation programmes, its conservative policy on booking profits on sale of investments, and the cleaning up of its balance sheet warranted an upgrade. The third quarter results, however, indicate that perhaps sentiment had run ahead of reality.

ICICI Bank's net profits rose by 33 per cent, while SBI's increased by 16.8 per cent. That's a deceleration in growth""""in Q2, ICICI Bank's net profits rose 41 per cent, while SBI's rose by 21 per cent.

Even more interesting is the fact that SBI's operating profit was lower than in Q3 of the previous year, while both SBI and ICICI Bank's operating profits in Q3 were lower than in Q2.

For SBI, even net profits in Q3 were lower than in Q2, and the only reason ICICI Bank was able to show higher net profits in Q3 compared to Q2 was because its provisions were lower.

While SBI has been hit by the decline in profits on sale of bonds, and the lack of a pick-up in corporate lending, ICICI Bank has been able to make that up by selling its portfolio of loans converted to equity, which have yielded handsome returns during the bull run.

The upshot has been that ICICI Bank's operating profits were Rs 389 crore for the quarter ended December 2002, rising to Rs 652 crore in Q3, FY 2004, an increase of 67 per cent.

If you think that's a flash in the pan, consider the nine-month operating profits till December 2003, which increased by 62 per cent over the corresponding nine-month period of 2002, after stripping out one-time gains.

In contrast, SBI's operating profits actually fell in Q3 compared to Q3 FY 2003, while operating profits over the nine-month period, again after stripping out one-time gains such as the profits from the debt buyback programme, rose by 17 per cent.

In Q3, ICICI Bank's operating margin was 21.7 per cent, compared to 13.8 per cent in Q3, FY 2003. In contrast, SBI's operating margin is 21 per cent, compared with 20.6 per cent in Q3, FY 2003.

In other words, ICICI Bank has been closing the gap between it and SBI, although the market has acted conversely, driving up the SBI stock relative to ICICI Bank. Note also that while provisions cover 64 per cent of ICICI Bank's NPAs, they cover 57 per cent of SBI's NPAs.

At current levels, and extrapolating current growth trends, the ICICI Bank stock is easily undervalued on a PE to growth basis compared with the SBI stock, which quotes at a PEG of about 0.40.

If current trends continue, ICICI Bank will continue to improve its performance at a faster pace than SBI. However, the revival of corporate lending will help the public sector giant.

The point, however, is that Indian bank shares as a whole are undervalued compared to their Asian peers.

Consider China's Minsheng Bank, which quotes at a PE of 34, Hong Kong's Hang Seng Bank at 20, HSBC at 23, Bank of East Asia at 26, Industrial and Commercial Bank at 17, Singapore's OCBC at 24, DBS at 17, Thailand's Krung Thai at 15, Bangkok Bank at 22 or Taiwan's Chang Hwa at 33.

With the Indian banking system having the lowest NPA to GDP ratio in Asia, there's still plenty of value in Indian banks, despite the slowdown in earnings.

With contribution from Amriteshwar Mathur