How ICICI Bank is closing the valuation gap with HDFC Bank

For a long time, HDFC Bank and ICICI Bank were the two ubiquitous private banks in India with a huge leadership over the other private sector players. While ICICI Bank continued to be the dominant player in terms of business till about 2016, it was always HDFC Bank that led the way in terms of valuations.

However, since 2016, HDFC Bank had taken a clear lead in terms of business volumes also, even as it kept NPAs under a tight leash.

Something has changed drastically for ICICI Bank in the last few years. To an extent, the exit of the former CEO and the induction of a new CEO brought about a sea change in the way investors looked at the bank.

The new management appears to have brought in aggression, focus and a greater sense of asset quality discipline in the bank. But there is a lot more to the story.
 

Here is what has been helping ICICI Bank narrow the valuation gap

The big story has been the net interest margin (NIM) convergence. For a long time, the NIM of HDFC Bank used to be around 4.5% and ICICI Bank was struggling around 3%. That gap had ensured that the valuation dislocation remained.

In the last 7 quarters, the NIM of HDFC Bank has come down from 4.3% to 4% while the NIM of ICICI Bank has build heft from around 3.55% to 4%. 


Check - HDFC Bank Share Price & ICICI Bank Share Price


This convergence of NIMs has been one of the main reasons why the valuations of the two banking stocks have been converging so rapidly in last few quarters. The altered business mix in favour of retail book has done a world of difference for the valuations of ICICI Bank as the NIMs have been on a constant uptrend. With an enhancement of the retail book, ICICI Bank actually saw its domestic NIMs expand to a level of 4.1%. 

There has been a convergence in the return on equity for both the banks. With improved profits and sharp profit growth, ICICI Bank has seen its ROE expand from 8.8% to 16.8% over the last 7 quarters.

During the same period, the ROE of HDFC Bank has expanded only from 15% to 16.8%, with the result that even on this profitability and capital efficiency parameter, both the banks are now at par. 

Of course, in terms of asset quality, HDFC Bank continues to score over ICICI Bank, but ICICI Bank has been fast catching up. In the latest quarter, ICICI Bank saw its provisions and slippages falling very sharply.

The gross NPAs are well under 4% with most of these NPAs provided for. That means net NPAs are now almost negligible. On a net NPA basis, there is not much to choose between these two banks. 

Lastly, we come to the aspect of valuations. How do HDFC Bank and ICICI Bank stack up on valuations? Since the lows of the pandemic, the ICICI Bank stock is up nearly 3-fold while the stock of HDFC Bank has gained about 70%.

That is relatively muted. If you look at the price to book ratio (P/BV) it is about 2.3 times for ICICI Bank and about 2.5 times for HDFC Bank. Under Sandeep Bakshi, ICICI Bank has outperformed HDFC Bank on most financial parameters, which explain the narrowing valuation gap. 

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