Khambatta Securities Ltd.

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1 Attractive Valuation Strong Buy Sector : Bank Private Target Price : Rs 284 Current Market Price : Rs 230 Market Cap : Rs 1,337 bn 52-week High/Low : Rs 393/216 Daily Avg. Volume : mn Shares in issue : 5.81 bn Face Value : Rs 2 Beta : 1.48 Pledged Shares : 0% Year End : March BSE Scrip Code : NSE Scrip Code : ICICIBANK Bloomberg Code : ICICIBC IN Reuters Code : ICBK.BO Nifty : 7,563 BSE Sensex : 24,871 Analyst : Raj Kumar Jha Price Performance ICICI Bank Bank Nifty Nifty Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Shareholding Pattern 3Q FY16 result update Review of results ICICI Bank s reported highly disappointing 3Q FY16 financial results. Higher provisioning for deteriorating asset quality dented the net profit during the quarter; however, net interest income (NII) was in-line with our expectation. During the quarter, bank reported 13.3% y-o-y growth in NII to Rs bn against our estimate of Rs bn, aided by healthy growth in advances and robust net interest margin (NIM). Advances grew by 15.8% y-o-y while NIM improved by 7 bps y-o-y to 3.53%. In 3Q FY16, bank reported 4.5% y-o-y growth in net profit to Rs bn on account of healthy non-interest income. Higher non-interest income protected the operating results. During the quarter, non-interest income grew by 36.4% y-o-y and 40.2% q-o-q to Rs bn on back of Rs bn profit on sale of 4.0% shareholding in ICICI Prudential Life Insurance Company. Adjusting the profit of Rs bn of ICICI prudential, bank reported 4% y-o-y decline in non-interest income to Rs bn. During the quarter, fee income reported 7.2% y-o-y growth to Rs bn. During the quarter, bank reported 22.4% y-o-y and 17.1% q-o-q growth in operating income to Rs bn while operating profit grew at slightly higher pace. During the quarter, operating profit grew by 30.2% y-o-y and 27.2% q-o-q to Rs bn due to lower operating expenses. During the quarter, operating expenses grew by 8.5% y-o-y and remained flat sequentially to Rs bn, resulting 411 bps y-o-y and 538 bps q-o-q reductions in cost-to-income ratio to 32.2%. Adjusting the one-time income from asset sale, cost-to-income ratio marginally increased annually but it declined sequentially to 36.91%. Worsening asset quality of bank increased the provisions and contingencies expenses in 3Q FY16. Provision and contingency expenses grew significantly to Rs bn, registering 190% y-o-y and 202% q-o-q growth, translating credit cost to 2.62% (annualised). Management indicated that the stress level is going to remain for next quarter; hence we have assumed elevated provisioning for next quarter. Significant deterioration in asset quality During the quarter, bank witnessed a significant deterioration in asset quality. Fresh slippage was Rs bn, of this Rs bn from restructured assets. During the quarter, slippage rate was 6.02% (annualised). The 2/3rd addition in GNPA was RBI s asset review and similar amount is expected in 4Q FY16 ( considering the stress level in certain loan accounts, RBI s directed to make the provisioning over two quarters Dec 2015 and March 2016). During the quarter, up-gradation & recovery was Rs 5.0 bn, write-off was Rs 6.56 bn and a small amount of Rs 0.38 bn sold to ARC during the quarter. Consequently net accretion to GNPA was Rs 53.5 bn, translating 4.72% of gross advances which grew 95 bps q-o-q. During the quarter, NNPA grew by 63 bps q-oq to 2.28%. During the quarter, bank restructured Rs 5.84 bn loans and taking total restructured loans of the bank to Rs bn against bn 2Q FY16. During the quarter, bank implemented refinancing under the 5/25 scheme for Rs 4.5 bn and SDR (Strategic Debt Restructuring) for about 16.7 bn. Management guided the SDR and 5/25 in pipeline is expected to be Rs 12.0 bn and 7.0 bn respectively for next quarter. During the quarter, capital adequacy ratio (CAR) of the bank was 16.74% (as per Basle III) and Tier I capital was 12.74% (including 9M FY16 net profit). Page 1

2 Retail continues to drive growth During the quarter, bank reported 17% y-o-y growth in domestic advances while total loan grew by 15.8% y-o-y to Rs 4,348 bn, primarily driven by retail. In 3Q FY16, retail portfolio registered 24.1% y-o-y growth to Rs 1,904 bn, constituting 43.8% of total advances against 40.9% in 3Q FY15, aided by each and every segment of retail portfolio except commercial business and outperformed by credit card and personal loan. During the quarter, home loan grew by 23.8% y-o-y to Rs 1,046 bn while personal loan grew by 41.8% y-o-y to Rs 91 bn and credit card loan grew by 34% y-o-y to Rs 51 bn. During the quarter, bank reported 14.6% y-o-y growth to Rs 4,073 bn, driven by healthy CASA deposits growth. During the quarter, saving deposit grew by 14.8% to Rs 1,269 bn while current deposit grew by 24.53% y-o-y to Rs 571 bn, consequently CASA ratio of the bank improved by 120 bps y-o-y to 45.2%. Future Outlook Considering the current deterioration in asset quality and similar guidance for next quarter, we have increased the credit cost, resulting massive change in our previous projection. We believe substantial addition in GNPA & NNPA and we also expect some ROA and ROE will moderate for next few quarters. Management has guided that NIM will be under pressure due to SDR, 5/25 scheme and healthy slippage. Management also guided that advances is expected to grow 16-20%, aided by retail growth above 25% and corporate loan growth in range of 10-15%. In deposits front, management guided a stable CASA on an average basis between 38% and 40%. Considering above facts, we have estimate 18% advances and deposits growth over FY15-17E and 13% NII & 9% PAT growth over the same period. We believe aggressive branch expansion and focus on retail business will drive the growth in medium to long term. We have revised our target Price downward, continuing with Strong Buy Considering the pressure on asset quality and net profit, we have revised our target price from Rs 370/share to Rs 284/share, implying Strong Buy. At CMP of 230, stock is available at 1.76x FY16E standalone adjusted book value (ABV) of Rs 130 and 1.59x FY17E standalone ABV of Rs 145. Adjusting the subsidiary companies valuation of Rs 66/share, ICICI bank s stock is available at 1.25x FY16E ABV of Rs 130 and 1.13x FY17E standalone ABV of Rs 145. Our valuation is based on sum-of-the-parts methodology. The valuation of ICICI Bank standalone is Rs 217/share based on 1.50x FY17E standalone ABV of Rs 145 (Earlier we have valued 303 based on 1.80x FY17E ABV of Rs 169/share) and the valuation of subsidiaries is Rs 67/share (after offering 30% discount). Consequently we arrive at target price of Rs 284/share per share, representing ~ 23% upside. At CMP of Rs 230, we continue with Strong Buy. Exhibit 1: 3Q FY16 Result Update (Standalone) INR Mn 3Q FY15 2Q FY16 3Q FY16 Q-o-Q change Y-o-Y change 3Q FY16E Variation from estimates NII 48,117 52,515 54, % 13.3% 55, % Other Income 30,917 30,074 42, % 36.4% 33, % Operating income 79,033 82,588 96, % 22.4% 88, % Operating expenses 28,663 31,004 31, % 8.5% 32, % Operating profit 50,370 51,584 65, % 30.2% 55, % provision and contigencies 9,797 9,422 28, % 190.3% 10, % PBT 40,573 42,163 37, % -8.4% 45, % Tax 11,683 11,862 6, % -40.3% 12, % PAT 28,890 30,301 30, % 4.5% 32, % Adj. EPS (Rs) % 4.0% % GNPA Ratio 3.40% 3.77% 4.72% 95bps 132bps - - NNPA Ratio 1.27% 1.65% 2.28% 63bps 101bps - - NIM 3.46% 3.52% 3.53% 1bps 7bps - - CASA 44.00% 45.10% 45.20% 10bps 120bps - - Cost-to-Income ratio 36.3% 37.5% 32.2% -538bps -411bps 36.5% -434bps PCR (x) 63.50% 57.40% 53.20% -420bps -1,030bps - - ROA 1.9% 1.9% 1.8% -7bps -8bps - - Adjusted Cost-to-income (x) 36.27% 37.54% 36.91% -63bps 64bps 36.50% 41bps Page 2

3 Change in our estimate Considering the current deterioration in asset quality and slippage, we have changed our projection down by 2.5% and 6.5% in NII and 9.7% and 16.1% for net profit for FY16E and 17E respectively. We expect higher credit cost and net NPA will have the negative impact on the book value, hence adjusted book value declined 11.8% and 14.1% for FY16E and FY17E to Rs 130/share and 145/share respectively. Exhibit 2 : Change in our projection Income Statement (Rs mn) Previous Projection Current Projection Variation from estimates FY16E FY17E FY16E FY17E FY16E FY17E Net interest income 221, , , , % -6.5% Other income 141, , , , % 0.1% Operating income 362, , , , % -3.9% Operating profit 231, , , , % -3.9% PBT 186, , , , % -16.3% PAT 131, , , , % -16.1% EPS (Rs) % -16.1% Adjusted book value per share (Rs) % -14.1% Exhibit 3: Financial Summary (Standalone) Income Statement (Rs mn) FY12 FY13 FY14 FY15 FY16E FY17E Net interest income 107, , , , , ,786 Other income 75,028 83, , , , ,774 Operating income 182, , , , , ,560 Operating profit 103, , , , , ,166 PBT 88, , , , , ,426 PAT 64,653 83,255 98, , , ,545 EPS (Rs) Balance Sheet (Rs mn) Shareholders' equity 604, , , , , ,155 Deposits 2,555,000 2,926,136 3,319,137 3,615,627 4,182,714 5,009,962 Borrowings 1,401,649 1,453,415 1,547,591 1,724,174 1,882,221 2,204,383 Cash and bank balance 362, , , , , ,996 Investments 1,595,600 1,713,936 1,770,218 1,865,800 1,714,913 1,953,885 Advances 2,537,277 2,902,494 3,387,027 3,875,221 4,529,707 5,435,648 Total assets 4,736,471 5,367,947 5,946,416 6,461,293 7,013,389 8,256,191 Adjusted book value per share (Rs) Exhibit 4: Ratio Analysis (Standalone) Key Ratios FY12 FY13 FY14 FY15 FY16E FY17E Net interest margin 2.57% 2.91% 3.11% 3.24% 3.36% 3.35% Cost-to-income ratio 43.05% 40.58% 38.32% 36.83% 35.75% 35.50% PAT margin 35.45% 37.48% 36.47% 35.80% 33.22% 32.61% GNPA ratio 3.62% 3.22% 3.03% 3.78% 5.50% 4.90% NNPA ratio 0.73% 0.77% 0.97% 1.29% 2.82% 2.51% RoAA 1.47% 1.65% 1.73% 1.80% 1.76% 1.75% RoAE 11.20% 13.10% 14.00% 14.53% 14.03% 14.32% Note: The values for certain metrics may differ from the reported data due to variations in the methods of computation Page 3

4 Guide to Khambatta s research approach Valuation methodologies We apply the following absolute/relative valuation methodologies to derive the fair value of the stock as a part of our fundamental research: DCF: The Discounted Cash Flow (DCF) method values an estimated stream of future free cash flows discounted to the present day, using a company s WACC or cost of equity. This method is used to estimate the attractiveness of an investment opportunity and as such provides a good measure of the company s value in absolute terms. There are several approaches to discounted cash flow analysis, including Free Cash Flow to Firm (FCFF), Free Cash Flow to Equity (FCFE) and the Dividend Discount Model (DDM). The selection of a particular approach depends on the particular company being researched and valued. ERE: The Excess Return to Equity (ERE) method takes into consideration the absolute value of a company s return to equity in excess of its cost of equity discounted to the present day using the cost of equity. This methodology is more appropriate for valuing banking stocks than FCFF or FCFE methodologies. Relative valuation: In relative valuation, various comparative multiples or ratios including Price/Earnings, Price/Sales, EV/Sales, EV/EBITDA, Price/Book Value are used to assess the relative worth of companies which operate in the same industry/industries and are thereby in the same peer group. Generally our approach involves the use of two multiples to estimate the relative valuation of a stock. Other methodologies such as DuPont Analysis, CFROI, NAV and Sum-of-the-Parts (SOTP) are applied where appropriate. Stock ratings Strong Buy recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (where applicable) by at least 15%. Market-perform recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (where applicable) between 5% and 15%. Underperform recommendations are expected to improve up to 5% or deteriorate, based on consideration of the fundamental view and the currency impact (where applicable). Analyst Certification I/We, Research Analysts and authors, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & Conditions and Other Disclosures: Khambatta Securities Limited (Khambatta Securities) is a full-service, integrated merchant banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. Khambatta Securities is one of the merchant bankers. We and our associates might have investment banking and other business relationship with companies covered by our Investment Research Department. Khambatta Securities generally prohibits its analysts, persons reporting to analysts and their relatives from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information and opinions in this report have been prepared by Khambatta Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of Khambatta Securities. While we would endeavor to update the information herein on a reasonable basis, Khambatta Securities is under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent Khambatta Securities from doing so. This report is based on information obtained from public domain and is believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and shall not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. Khambatta Securities will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. The value and return on investment may vary because of changes in interest rates, foreign exchange rates or any other reason. Khambatta Securities accepts no liabilities whatsoever for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to understand the risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to change without notice. Khambatta Securities or its associates might have received any compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of investment banking or merchant banking, brokerage services or other advisory services. Page 4

5 Khambatta Securities encourages independence in research report preparation and strives to minimize conflict in preparation of research report. Khambatta Securities or its analysts do not receive any compensation or other benefits from the companies mentioned in the report or third party in connection with preparation of the research report. Accordingly, neither Khambatta Securities nor Research Analysts have any material conflict of interest at the time of publication of this report. It is confirmed that Research Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Compensation of our Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions. The Research Analysts engaged in preparation of this Report (a) may or may not have any financial interests in the subject company or companies mentioned in this report; (b) do not own 1% or more of the equity securities of the subject company mentioned in the report as of the last day of the month preceding the publication of the research report; (c) do not have any other material conflict of interest at the time of publication of the research report. It is confirmed that Research Analysts do not serve as an officer, director or employee of the companies mentioned in the report. Neither the Research Analysts nor Khambatta Securities have been engaged in market making activity for the companies mentioned in the report. We submit that no material disciplinary action has been taken on Khambatta Securities by any Regulatory Authority impacting Equity Research Analysis activities. This report has been prepared by Khambatta Securities. Khambatta Securities has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed. Page 5