ICICI Bank (IBN) Stock: Digital Transformation A Double-Edged Sword

Elevator Pitch

I rate ICICI Bank’s (NYSE:IBN) [ICICIBC:IN] stock as a Hold.

I previously reviewed IBN’s financial performance for the second quarter of fiscal 2023 (YE March 31) with my earlier write-up for ICICI Bank published on October 25, 2022. With the current article, I provide an update of my thoughts on ICICI Bank, after reviewing the company’s recent Analyst day presentation.

I have a favorable view of IBN’s digital transformation efforts, but digitalization is a double-edged sword for the company. ICICI Bank has underinvested in its physical branch network in recent years with its focus on digitalization, and I am worried about the substantial investments that ICICI Bank needs to make to grow its branch network in the near future. Moreover, ICICI Bank’s valuations are already approaching 10-year historical highs. Therefore, I have chosen to retain my Hold rating for IBN.

Positive Takeaways From Recent Analyst Day Relating To Digital Transformation

ICICI Bank recently hosted the bank’s 2022 Analyst Day in December, and I am particularly impressed with IBN’s progress in relation to digital transformation. I highlight key takeaways from ICICI Bank’s recent Analyst Day below.

More than 90% of ICICI Bank’s transactions are already digital in nature currently, and this process of digitalization has helped to drive a +28% YoY in IBN’s transaction value per customer for the first 10 months of 2022. During the same period, IBN’s mortgage loans, automotive loans, and personal loans that were sourced from digital channels grew by approximately +20%, +50%, and +80%, respectively in YoY terms.

There are specific business segments which have benefited tremendously from digital transformation that are worth noting.

Earlier, Business Insider India reported on November 29, 2022 that ICICI Bank recently introduced “iLens, a digital lending solution” to the market in July 2022 which “digitizes the entire mortgage lending process.” iLens has been a huge success, having garnered 24,000 active users and achieved a client penetration rate in excess of 80% in just months following its launch. Notably, iLens currently handles around 95% of all new mortgages for ICICI Bank, and this has been the key driving force behind a +44% YoY increase in Non-Resident Indians or NRI home loans for IBN in 1H 2022.

Separately, ICICI Bank’s SME (Small-to-Medium Sized Enterprises) loan book and business banking loan book have expanded by +27% and +43%, respectively in the 9M 2022 financial period. This strong growth in ICICI Bank’s loan books should be largely attributable to IBN’s new “electronic bank guarantee facility” and new “instant overdraft facility” which have simplified the financing process for its corporate customers.

Also, IBN’s customer acquisition process for credit cards is now fully digital, and it is noteworthy that about 14% of its current credit card issuances can be completed in under half an hour. ICICI Bank’s credit card business has been growing very strongly thanks to its digitalization efforts, and this is reflected in the key metrics for this business segment. The credit card book for IBN jumped by +68% between end-September 2021 and September 30, 2022, while ICICI Bank’s credit card spends and transactions increased by +43% YoY and +36% YoY, respectively in Q2 FY 2023.

Although ICICI Bank’s progress in the area of digitalization is commendable, this doesn’t make IBN a perfect investment candidate. In fact, the focus on digital transformation is a double-edged sword, as I will highlight in the subsequent section.

Spotlight On ICICI Bank’s Branch Network Expansion

ICICI Bank’s emphasis on digital transformation (as outlined in the preceding section) appears to have come at the expense of a slower pace of branch network expansion in recent years.

According to a research report (not publicly available) titled “India Financials: Stars Aligned” published by Sanford Bernstein Research on November 21, 2022, IBN’s market share within the four largest Indian private sector banks in terms of branch network size has dropped significantly from 34% in FY 2017 to 29% for FY 2022. Specifically, ICICI Bank saw a net decline of -58 bank branches in fiscal 2021 and added only 152 bank branches (on a net basis) in FY 2022 as highlighted in the report. In contrast, IBN added a relatively higher 450 net new bank branches in FY 2020.

This means that ICICI Bank is most probably going to ramp up its investments in new branch additions in the short to medium term, and this could potentially hurt IBN’s future profitability and cash flow. At the company’s most recent Q2 FY 2023 earnings call, an analyst highlighted competitors’ “very aggressive branch expansion” plans, and ICICI Bank acknowledged that it “would continue to expand our branches” and it expects its “branch numbers going up over the next couple of quarters.”

Valuations Are Close To Historical Peak

ICICI Bank currently trades at a trailing price-to-tangible book or P/TBV ratio of 3.11 times based on valuation data taken from S&P Capital IQ.

The 10-year mean and peak P/TBV multiples for ICICI Bank are 2.18 times and 3.46 times, respectively. Even if the market re-rates ICICI Bank’s valuations and allows it to trade at its historical peak P/TBV multiple (3.46x) again, this will only be equivalent to a modest upside of +11%.

Using a rule of thumb that an investment candidate requires an upside potential of at least 15%, ICICI Bank doesn’t deserve a Buy rating.

Concluding Thoughts

A Hold investment rating for ICICI Bank is fair and reasonable. While IBN has made considerable progress on the digital transformation front, it has lagged behind its peers in terms of physical branch additions which is critical to deposit growth. More importantly, ICICI Bank’s valuations are at the high end of its 10-year historical trading range.