IBN - ICICI Bank: A Mix Of Positives And Negatives

2023-06-01 11:19:06 ET

Summary

• IBN's key positives are its healthy asset quality metrics and favorable top line prospects.
• The key negatives for ICICI Bank are expectations of higher operating costs and a gradual normalization of its net interest margin.
• A Hold, rather than a Buy or Sell, is the most appropriate rating for IBN, as the stock has a mix of positives and negatives.

Elevator Pitch

My investment rating for ICICI Bank Limited's ( IBN ) [ICICIBC:IN] stock stays as a Hold. The focus of my earlier write-up for IBN published on March 21, 2023 is the value creation potential associated with a partial sale of ICICI Bank's equity interest in insurance company ICICI Lombard.

With this latest update, I identify the key positives and negatives that have a bearing on ICICI Bank's appeal as a potential investment candidate. My analysis leads me to the conclusion that IBN isn't an outright Buy or a Sell, as there are both positive and negative factors affecting the company's prospects. In that respect, I have made the decision to keep my Hold rating for ICICI Bank.

Robust Top Line Expansion And Good Asset Quality Are Key Positives For IBN

ICICI Bank's healthy revenue growth prospects and strong asset quality are the stock's main investment merits.

According to the consensus financial projections sourced from S&P Capital IQ , IBN is forecasted to achieve positive, double-digit percentage top line (net interest income and non-interest income combined) expansion in each of the four quarters for the new fiscal year, FY 2024 (YE March). The favorable revenue outlook for ICICI Bank is consistent with the company's management commentary at its Q4 FY 2023 earnings briefing (call transcript taken from S&P Capital IQ ) and its recent quarterly loan growth metrics.

At the company's most recent Q4 FY 2023 earnings call in late-April, IBN's CFO emphasized that he is "not seeing anything today, which suggests that there could be any material drop (in loan growth)" or "that demand (for loans) would be inadequate." Also, ICICI Bank's total loans grew strongly by +19% YoY and +5% QoQ in the final quarter of fiscal 2023 as revealed in its results presentation slides .

In terms of loan growth by segment, retail, business, and SME (Small to Medium Sized Enterprises) loans for IBN increased by +28%, +35%, and +19%, respectively in YoY terms for FY 2023. The increase in the penetration of online internet banking services and mobile banking applications is the key digitalization-related growth driver for ICICI Bank's retail banking business. Separately, IBN disclosed at its fourth quarter results call that its "SME and business banking" segments "have a market share that is lower than our overall market share." This indicates that there is room for further share gains for ICICI Bank's business and SME banking segments.

With respect to asset quality, there are positive read-throughs from some of ICICI Bank's key metrics.

ICICI Bank's Gross Non-Performing Assets or GNPA ratio improved from 3.60% as of March 31, 2022 and 3.07% as of end calendar year 2022 to 2.81% at the end of the most recent quarter. The Net Non-Performing Assets or NNPA ratio for IBN also declined by -28 basis points YoY and -7 basis points QoQ to 0.48% as of March 31, 2023 (end-Q4 FY 2023).

The proportion of IBN's loans with a credit rating of BB or lower went down from 3.6% a year ago to 0.8% at the end of Q4 FY 2023. During the same period, ICICI's non-performing loans as a percentage of its total loans decreased from 1.1% to 0.4%.

I look at the major downside risk factors for ICICI Bank in the subsequent section.

ICICI Bank's Key Negatives Are Net Interest Margin Normalization And Meaningful Expense Growth

Looking forward, a faster than expected pace of net interest margin normalization and operating cost increases pose the most significant risks to ICICI Bank's future earnings.

IBN's net interest margin increased by +52 basis points from 3.96% in fiscal 2022 to 4.48% for FY 2023, and this was the key driver of a +30.0% growth in net interest income for the bank last year. But ICICI Bank acknowledged at its Q4 FY 2023 earnings call that the "growth in (future) earnings would be more driven by growth in the business (e.g. loan growth) than any increase in (net interest) margins for sure."

Specifically, the sell-side analysts' consensus financial estimates (source: S&P Capital IQ ) point to ICICI Bank's net interest margin decreasing to 4.44%, 4.36%, 4.21% and 4.20% for FY 2024, FY 2025, FY 2026, and FY 2027, respectively. It is inevitable that IBN's net interest margin gradually normalizes to levels (below 4%) seen prior to this current rate hiking cycle over time. India's central bank has put a pause on interest rate hikes earlier this year, as reported in an April 6, 2023 Bloomberg news article .

Apart from net interest margin normalization, it is also worth paying attention to the increase in IBN's operating costs.

The cost-to-income ratio for ICICI Bank rose by 1 percentage point from 38.2% in Q3 FY 2023 to 39.2% for Q4 FY 2023, and there are good reasons to expect higher operating expenses for IBN going forward.

ICICI Bank has guided at its Q4 FY 2023 results briefing that it expects "significantly higher branch additions next year than what we have seen this year." As a reference, IBN's branch network had already expanded by a meaningful +9% to 5,900 for full-year FY 2023.

Also, IBN's technology spend as a proportion of total costs increased from 8.6% for FY 2022 to 9.3% in FY 2023. ICICI Bank had noted at the bank's most recent quarterly earnings call that it aims to "continue to make investments in technology" and "expand our technology and digital offerings." As such, it will be realistic to expect elevated technology spend for IBN in the foreseeable future.

Concluding Thoughts

I like ICICI Bank's loan growth prospects and healthy asset quality metrics. But I am concerned about the downside risks relating to IBN's earnings like higher-than-expected operating costs and faster-than-expected net interest margin normalization. In my opinion, IBN's shares are deserving of a Hold rating.

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