Kotak pips ICICI

But the real lessons could be much bigger than market cap!

As the Bank Nifty went through its share of tumult, a quite shift may be underway in the banking space. As the market cap of Kotak Bank crossed the market cap of ICICI Bank, the news did surprise a lot of analysts and fund managers. However, there is a big lesson in this and that pertains to how the banking industry is shifting subtly.

Valuations inside out…

Based on traditional valuation metrics, ICICI Bank may appear to be a better valuation case. ICICI Bank has a P/E ratio that is 1/3rd of Kotak Bank and a P/BV that is 1/4th of Kotak Bank. Above all, ICICI Bank has a much more attractive dividend yield compared to Kotak Bank. Based on any quick-look analysis, ICICI Bank should make a more favorable investment case compared to Kotak Bank. But if you look at the comparative chart below of ICICI Bank and Kotak Bank over the last 5 years, the outperformance of Kotak over ICICI Bank is phenomenal. It is essential to understand why this is so.

There is a leverage angle…

The first difference comes from the cash flow from operations. While ICICI Bank had negative cash flows from operations as of full year 2015, Kotak Bank had a healthy positive cash flow from operations. But the cash flow from financial activities was substantially larger in case of ICICI Bank as compared to Kotak Bank. The market is willing to give a higher valuation for cash flow from operations than from financing. The debt / equity ratio of ICICI Bank is almost 1.5 times that of Kotak Bank and this high leverage is seen as a high risk factor in case of the banking industry. This also explains why ICICI Bank has a higher ROE compared to Kotak Bank but a lower return on assets (ROA), a key metrics in case of the banking industry.

Spreads and doubtful assets…

The ICICI stock took a hit after it announced a sharp rise in gross NPAs to 5.8% this quarter. Kotak with gross NPAs of around 2.3% is in a more comfortable situation. If you look at the Net Interest Margins (NIMs) of Kotak, they are almost 50% higher than ICICI Bank as of 2015. The moral of the story seems to be that globally banking is shifting from focus on return enhancement to risk management. Banks that are getting NIMs with minimal risk are being rewarded. This gap is symbolic of that global trend. ©

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