Market Walk

ICICI and HDFC – What is this valuation battle between these 2 private banks?

The big news may be about the merger of HDFC Bank and HDFC Ltd. However, there is a convergence of a different kind that is happening; that is in the valuations of HDFC Bank and ICICI Bank and here is why it is significant. But, what is this convergence all about?

ICICI Bank and HDFC Bank

Back in 2010, HDFC Bank was trading at a P/BV of 3.5X while ICICI Bank was at a P/BV of 1.7X. with the uncertainty till around 2017, the valuations of ICICI Bank had been stifled. Things have changed after Sandeep Bakshi took over as the CEO of ICICI Bank and gave it a sharp retail push, changing its asset mix and with focus on asset quality. Now both banks are converging on P/BV with ICICI at 2.3X and HDFC Bank at 2.5X.

This has been driven by two other sets of convergence. First is the net interest margins or NIMs. The NIM of ICICI Bank has moved from 3.3% to 4% in the last 8 quarters while in the same period, the NIM of HDFC Bank moved lower from 4.4% to around 4%. That has forced the valuations to converge. The other reason is the ROE. In the last 8 quarters, the ROE of HDFC Bank improved from 15% to 16.8%. However, during the same period, the ROE of ICICI Bank has improved from 8% to 16.8% on a better asset mix. This is the other key factor that has led to ICICI Bank and HDFC Bank converging on valuations. But is this kind of convergence truly justified?

The essential difference

Looking at the convergence of the valuation ratios of ICICI Bank and HDFC Bank does give insights, but that is only part of the story. We also need to look at how these two banks have grown historically. ICICI Bank has consistently chased growth in volumes and top line and asset quality have always been a tad incidental for their core business. HDFC Bank, on the other hand, has focused on asset quality primarily and allowed the business to grow on momentum. While both approaches have their own merits and demerits, the true valuation test of a bank is never during good times but amidst bad times. These are the times when HDFC Bank has held out better and also grown its market share.

Markets looking for stories

The markets always look for stories that are easy to fathom. For instance, HDFC Bank has headwinds like change at the top, merger impact with HDFC etc. This has led to the stock becoming languid in its movement in the last few months. On the other hand, ICICI Bank is now being projected by the market as a bank that has suddenly found its mojo and shifted from a top-line DNA to an asset quality DNA. While both sides of the argument are partially correct, they hardly give the full picture. The real test for ICICI Bank will come when it has to take on another crisis in the market. That will offer a better comparison!

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