HDFC BANK-ICICI Bank valuation gap narrows to a decade’s low
HDFC Bank’s asking rate was twice that of ICICI Bank’s in the past
The correction in banking stocks since March has reduced HDFC Bank’s valuation premium over ICICI Bank. From 4.2 times FY19 book, HDFC Bank’s asking rate has dipped to 2.8 times FY21 estimated earnings. ICICI Bank’s valuation, meanwhile, has improved from 1.8 times FY19 to 1.9 times FY21 estimated book.
In other words, HDFC Bank’s valuation premium, which was twice more than that of ICICI Bank for most of the previous decade, is melting fast. At around 37 per cent premium to ICICI Bank, the gap is at a decadal low (see table). Even on FY20 basis, the figure is the lowest in a decade. The difference between the two stocks now is just about mirroring their balance sheet size. HDFC Bank’s balance sheet at ~10.03 trillion in FY20 is 36 per cent larger than ICICI Bank’s ~6.45 trillion. So, what justifies this trend and how sustainable is it? These key parameters could provide the answers:
Asset quality picture
Numbers indicate that the gap between the two banks became more pronounced from FY16, since ICICI Bank was caught neck- deep in cleaning up its books, which came at the cost of the bank’s growth. Come FY20, when the bank had more or less taken care of its legacy loan issues, the Street started ascribing better multiples.
On the other hand, HDFC Bank’s gross non-performing assets (NPAS) ratio has been inching up, breaching its sacrosanct one per cent mark. From FY17 till date, the bank’s gross NPAS have increased from 1.1 per cent to 1.4 per cent as on June 30 (Q1FY21), though its net NPA ratio is less than one per cent.
These numbers are still the best in the sector.
On the contrary, after peaking at 9.5 per cent in FY18 ICICI Bank’s gross NPA reduced to 6 per cent in Q1, while its net NPA at 1.5 per cent has fallen below its pre -asset quality review (AQR) level. Analysts at Kotak Institutional Equities feel ICICI Bank could see further improvement in asset quality, while HDFC Bank’s may deteriorate marginally (see table).
Loan mix
The composition of retail and wholesale loans also has helped in improving the Street’s perception of ICICI Bank. Taking lessons from the AQR, ICICI Bank now has a larger share of retail loans than HDFC Bank (see table). Primarily reckoned as a retail lender, HDFC Bank’s share of retail assets has steadily fallen over the years and at 47.3 per cent in Q1, it is back to FY15 level.
Another advantage I CICI Bank enjoys is that its loan book leans less towards the unsecured p or tfolio. Compared to HDFC Bank’s 16.6 per cent unsecured exposure out of retail book (5.5 per cent from credit cards and 11 per cent from personal loans), half of ICICI Bank’s retail assets come from home loans. And, the unsecured portion is restricted to 9.4 per cent of ICICI Bank’s retail book.
Importantly, ICICI Bank is expanding its retail book faster than the overall portfolio — up 20 per cent year-on-year (YOY) in Q1, while HDFC Bank’s retail growth has slowed— up 7 per cent YOY in Q1.
However, analysts at Axis Securities say HDFC Bank’s selective l ending parameters and strong risk management will keep its operating performance steady.
Valuation trend
Gautam Chhugani of Bernstein Research believes there is scope for further reduction in valuations. Any adverse asset quality surprises, though, could alter expectations. Prakhar Sharma of Jefferies feels that as ICICI Bank has ticked all the right boxes it is well-placed to take on asset quality issues.
On Saturday, HDFC Bank will reveal its Q2 results and ICICI Bank’s numbers are anticipated by month-end. These will determine if the trend can sustain.