The Hindu Business Line : ICICI Bank: Aggressively priced

AN INVESTMENT in the public offer of ICICI Bank can be avoided for now. The offer is aggressively priced relative to its past financial performance. The valuation is also higher vis-a-vis to that of many of its peers. Growing at a healthy pace, ICICI Bank is one of the more profitable banks in the country. It has a strong position in almost all fast-growing financial service segments. Thus, it has the potential to deliver reasonable long-term returns even on an investment in this offer. However, given the valuation for the offer, the downside risks are also high. There are stocks within and outside the banking sector that would offer better bang for the buck. Entry into ICICI Bank can be considered at a date when the valuation is more attractive.

Relative value

Based on the performance in the 12 months ended September 2005, at Rs 545, ICICI Bank is valued at a PEM of 18 times.

This looks attractive when we consider that another private sector bank, HDFC Bank, with an equally impressive track record of growth is trading at a higher PEM of 28 times its earnings. We, however, need to consider the higher capital adequacy ratio in the case of HDFC Bank. The Tier-II capital of HDFC Bank is only 30 per cent of its Tier-I capital. For ICICI, Tier-II capital at end-September 30, worked out to 60 per cent of Tier-I. This means HDFC Bank can grow its earnings for a longer time without any expansion in its equity capital. If we assume that such additional resources, its asset base would expand and so would its profits. Such higher profits could bring down the PEM to a more reasonable 21. That still leaves a gap in the valuation between HDFC Bank and ICICI Bank. HDFC Bank's profitability however is better than that of ICICI. This means for the same rupee of invested capital, HDFC Bank would deliver more profits than ICICI Bank.

This is not to say HDFC Bank is more attractive than ICICI Bank.

This only highlights that at Rs 545, ICICI Bank's stock is not trading very cheap compared to HDFC Bank.

Adjusted for lower profitability, ICICI Bank's valuation is almost on a par with that of HDFC Bank.

It would be fair to say both stocks are aggressively priced, factoring in almost all the promise offered by their managements and the brands.

Justifying value

Can the offer price of Rs 545 be justified? Generally private sector banks have grown faster than the public sector outfits. ICICI Bank, in particular, has out-performed most other private sector banks.

If growth of private sector banking continues to grow at such rapid pace, this offer price would be justified.

This, too, will not lead to value generation in a short period. It may require a holding period even of at least three years.

Another scenario that would justify the valuation is an improvement in the profitability of ICICI Bank. This bank's net interest margin (excess of rate at which funds are lent over the rate of borrowing) is considerably lower than that of many private banks. Any improvement in this margin can boost profit growth significantly, justifying the valuation. The question, however, is how long will it take to improve the margins.

Again, the focus on housing finance, which now accounts for a third of its assets, may not improve margins. In addition, if the Reserve Bank of India raises capital adequacy for housing finance to 100 per cent, then, the capital required would increase further for ICICI Bank, reducing the profitability further.

There are some plus points in the form of value of certain assets in ICICI Bank's balance-sheet. ICICI has valuable investments in securities broking, asset management and insurance. The value of these businesses could be Rs 9,000-10,000 crore. This would work out to about Rs 100 per share. This is the known part and much of this value is already factored into ICICI Bank's price.

The unknown part is the value of its investments in the equity shares of other firms. It has about Rs 1,100 crore invested in other firms. ICICI Bank has not disclosed the value of this portfolio. Besides, its non-performing assets could itself turn out to be a hidden asset. If a portion of these loans start performing because of the continuing improvement in industrial activity, then, that strongly support the valuation.

Lower margin of safety

In the end, it is about the margin of safety to an investor. ICICI Bank's return on net worth of about 18 per cent is not compatible with the stock's present valuation.

In addition, this offer, along with the overseas share offering, would raise funds equal to 60 per cent of the bank's net worth. Expanding profitably the size of the balance-sheet, which is now close to Rs 2-lakh crore, to accommodate such a huge increase in net worth, will remain a challenge. This suggests that the return on an investment in this offer for investors would only be in line with that of the market and even that may require a longer holding period.

As there are investment avenues that promise better returns with a lower level of risk, it would be better to avoid this offer now. Investments can be considered when the pricing is more in tune with its financial performance over the years.

Offer details: ICICI Bank's public offer is for 9.9-crore shares. The bid opened on December 1 and closes on December 6. The price band for the offer is Rs 505 to Rs 545. The lead managers are DSP Merrill Lynch and JM Morgan Stanley. Retail investors would be offered shares at a 5 per cent discount to the offer price.

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