It’s amazing how things can change in such a short span. Last year, when I was pencilling the top pick for 2017, demonetisation was announced, Trump was elected as the US president and most market analysts had painted a picture of gloom and doom. These are typical times that a value investor cherishes. My last year’s pick was Reliance Industries. It has done well (up 67.7% YTD), surpassing even my expectations.
However, this year the overall mood towards equity is very positive. Contrary to what most people had predicted at the start of the year, Nifty is up 25% YTD with high beta cyclicals leading the way. Such a sharp rally amid subdued returns of other asset classes (real estate, fixed income, and gold) has resulted in equities becoming the most preferred asset class among households. In such an environment, one needs to be cautious in selecting stocks. As Warren Buffett says, “One should be afraid when everybody is greedy.” Nonetheless, investment opportunities always persist. So, my top pick for the New Year is ICICI Bank. Here’s why.
The three 'R's
Recognition, re-capitalisation and now resolution. While investing in any company, I am a strong believer that it is the macro environment rather than stock-specific factors which drive return. Here, I think, things seem to be, finally, moving. India’s corporate lenders have for long been kicking the can down the road. Projects which were bid in the past decade under optimistic assumptions have become unviable, owing to the slowdown. In the early part of this decade, most banks were unwilling to recognise these mistakes. However, in recent years, the central bank has forced a lot of recognition in these banks. Owing to lack of capital, especially in public sector banks (PSBs) and India’s poor bankruptcy framework, things were moving at a slow pace. But with the recent capitalisation of PSBs, along with the new bankruptcy code, there is light at the end of the tunnel. While this could entail pain in the near term as it will cause more haircuts, it will end the seven-year slowdown and, finally, help the bank focus on growth rather than spend time on managing non-performing assets.
Better of the lot
After spotting the macro theme, the next step is to compare it with peers. This is where I think ICICI Bank really stands out among corporate lenders. Among private sector corporate lenders, its stress recognition is at a more advanced stage compared with PSBs, despite the capital infusion by the government. Hence, ICICI Bank is better placed owing to lower stressed assets and a stronger retail franchise.
Are there any freebies?
While buying socks or stocks, I always look for freebies — perhaps it’s my Marwari DNA! This is where I think ICICI Bank scores well above its peers. Its subsidiaries in life insurance, general insurance and asset management are among the largest and fastest growing among peers. Despite making up for 30% of the stock value, the subsidiaries are least discussed in my interactions with most institutional clients. Further, these subsidiaries are the best play on India’s financialisation story. Given the bank’s large customer base, there are very high synergies that the subsidiaries have with the bank’s core lending book. While life and general insurance are listed, the AMC and securities businesses are still not. In other words, there is further scope for value unlocking.
Rare value in an expensive market
While investing, the entry price of a stock is extremely critical. As Buffett mentions that a good company may not necessarily be a good stock. Here again ICICI Bank offers a lot of comfort. The stock trades at 1.3x FY19 core book. This is over 50% discount to its private sector retail lenders, HDFC Bank and Kotak Mahindra Bank. Also, it trades at 20% discount to private sector corporate peer Axis Bank, despite being at a more advanced stage of its recognition cycle. Also, relative to its own history, the stock is 20%-25% cheaper than what its valuations were in the previous growth phase (2003-08). While the stock is up 36% in 2017, its three-year return is zero and last 10-year CAGR is just 4% — same as the savings rate. Hence, when things improve it is only a matter of time before investors start valuing it more appropriately.
Good times ahead
In short, ICICI Bank fits all the desired criteria that a long-term value investor would look out for. While there could be some volatility, the stock is poised to deliver good return over the long-term. To me the bank’s prospects are very similar to that of Reliance, a year ago. After staying rangebound for almost a decade, RIL rallied sharply as it delivered on execution. While past performance is no guarantee of future return, I would be very happy even if ICICI Bank performs half as well in 2018 as RIL did in 2017.
The brokerage has a buy call on the stock, but the writer does not own the stock in his personal capacity
