• Team Carnelian

Carnelian Wealth Creators Series 1.0 - USD 500bn giant in making…

Updated: May 10


Greetings from Team Carnelian.


Hope you and your family are safe through the second wave of the pandemic.


“Choosing the wrong people to lead an organization is the No.1 risk for businesses” – Warren Buffet, WSJ 2021”


So is the reverse true as well. It is a well-established fact that the Quality of Management determines large part of wealth creation specially when combined with a good quality business.


At Carnelian, we spend a considerable amount of time discovering/re-discovering such management teams. Often, we are asked the question - which managements will you bet on for the next 10 years who will create value for shareholders? Welcome to the Carnelian Wealth Creator Series, wherein we will share our views on such managements that have “IMPRESSed” us from time to time and have the potential to create serious wealth.


We believe the quality of management plays a very important role in building the organisation DNA/culture which is the most important ingredient for long term wealth creation for all stakeholders. There is no shortcut nor one way of assessing such managements. It requires hours of meeting/interactions with people at all levels of an organisation, customers, vendors, ecosystem etc over a long period of time before you arrive at a conclusion.


We have created our own little framework “IMPRESS” (detailed commentary follows) encompassing numerous qualitative and quantitative checks to assess managements on different parameters.


In this letter, we would like to present one such leadership team which we believe has the potential to create USD 400-500 bn of wealth in this decade - The ICICI Group which is undergoing a transformational journey under the able leadership of Mr. Sandeep Bakshi, who was appointed as CEO in Oct, 2018.


We came fairly IMPRESSed post our first meeting with Sandeep in 2019 wherein he articulated the strategy of an “input driven approach” and doing what’s right for the customer, without focusing on the “output”. His focus was to build predictability by doing away with lumpy provisions and focus on “risk calibrated growth” instead of “only growth”. We have been tracking The Group since then and meeting people at all levels across various group companies.


Leadership matters but it matters even more when it is about the change or being catalyst, as it requires bold thinking, willingness to steer cultural change, openness to accept failure and most of all humility to learn and adapt. We have seen Sandeep display each of these characteristics.

We can summarise the transformation journey (the inputs) across the undermentioned pillars:


1. Risk culture transformation: From “only growth focused” to “risk calibrated growth”

2. HR culture transformation: One Bank, One Team, One Goal

3. Technology culture transformation: Renewed thrust & continue on existing strength

4. Customer culture transformation: 'Fair to Customer, Fair to Bank'


1. Risk Culture: (from “only growth focused” to “risk calibrated growth”)


We came fairly IMPRESSed with Sandeep post our first meeting wherein he articulated his strategy was to do away with lumpy provisions and focus on “risk calibrated growth” instead of “only growth”. He and his team took a number of bold decisions and implemented them ruthlessly.


· Given ICICI genesis, it always had a special Project Finance Group; moving away from the lumpiness of this business Sandeep decided to scale down project finance thus sending a very strong message to the organisation about his strategy/intention. While they still continue to do project lending as a part of the corporate banking group, there is no specific focus on project finance which is always prone to bringing in lumpy provisions.

· Relationship managers were made accountable for the delinquencies.

· Risk frameworks were well defined and risk teams got renewed empowerment. Freedom within Framework became the Mantra.


a. Granularity helping reduce risk with growth:


· Retail loans as a part of overall advances increased from 57% to 67 % from FY 2018 to FY 2021 with 85% of the retail portfolio secured largely comprising of mortgage loans, vehicle loans etc.

· International exposure down from 13% to 5% of overall book from FY 2018 to FY 2021

· Exposure to top 10 groups as percentage of advances improved from 14.3% to 11.6% from FY 2018 to FY 2021

· As a result of the above actions – Gross NPL’s as a % of advances reduced drastically from 8.5% to 5.8% from FY 2018 to FY 2021 – with more granularity in advances presently.

· Despite all the above, the bank was able to grow their overall advances from INR 5.12tn to INR 7.34tn from FY 2018 to FY 2021(CAGR of 13%)


The journey in numbers

General Insurance business - moving away from riskier business, strict control over loss ratio and zero NPAs


· Realising the risky nature & working capital intensity of crop insurance business, ICICI Lombard management stopped the crop business and reduced it from 19% to 0% GDPI from 2018 to 2021.

· Loss ratios brought down from 81.5% to 68.6% from 2016 to 2021, is a testimony of superior underwriting.

· On the investment side it has a zero NPA track record since inception.

· This risk calibrated growth approach has helped the insurance business in delivering 20% growth with 20% ROE over last 20 years (We call ICICI Lombard 20:20:20 internally 😊).

2. HR Culture

One Bank, One Team, One Goal:

The new leadership embarked upon a strategy - one bank, one team, one goal with the view to break silos, undesirable fiefdoms and deliver better services to the customer and arrive at a focus and mission to unlock synergies with various group companies. Sr. General Managers at the bank no longer sit on a different floor and in separate cabins but with their team members. Hierarchy has been slashed and designation has been aligned to the functional roles instead of seniority.


A Bank which had the culture of silos, was transformed & guided to think as one team. We were amazed to see a big “Shift” in language, motivation and efforts, when we spoke to various employees across various departments be it in risk, operations, relationship managers or even technology (since we are ex-ICICI employees, it became bit easier to get firsthand feedback). To us this kind of input is far more valuable than any management guidance/commentary.


An employee said “Sandeep is such a humble leader, very often I get a call from him”. This is an employee 5 / 6 levels down in the hierarchy. We have heard stories of Branch Managers getting calls from Sandeep to check on Branch level challenges/performance. Risk guys told us that they are fully empowered to avoid any risky business outside of the agreed parameters. “Freedom within Framework” is the new Mantra.


Interestingly, ICICI has done away from the Stars culture to make sure it is only a team and no Stars. This is again to our liking. We dislike the Star culture and don’t see many firms with a Star culture building a sustainable business. It also starts with the leaders. All the leaders in ICICI Bank at key positions (Sandeep, Anup, Sandeep Batra, Visaka, Rakesh, Kannan, Bhargava, Vijay, Nimesh) are humble & understated but very capable and solid leaders in their own right. Each of them runs complex, highly competitive business/verticals in a very efficient way.

3. Technology and digital agility transformation


Good leaders never disturb good practices from the past; ICICI Bank was always ahead in digital capabilities. New leadership acknowledged that and renewed its focus with a view to make it more customer friendly and keeping pace with new development.


“Digital is core to our strategy of integrating across ecosystems, smooth onboarding and transactions, growth in liabilities and analytics for risk selection.” – Sandeep Bakshi

“We think of ourselves as a tech company that also does insurance — I don’t think we are there, but that’s the mindset and agenda”. – Bhargav Das Gupta


The Banks numbers are a testimony to their digital capabilities:

· UPI transactions - 14% volume share and ranked 3rd in the industry

· Fast tag collections - 37% market share by value in Q4 and ranked 1st in the industry

· Personal loans - 90% sourced online (instant and digital onboarding)

· Credit cards - 75% sourced digitally

· Fixed Deposits - 56% sourced via digital channels

· SIP’s - 64% initiated via digital channels


During the pandemic, the Bank was able to grow its retail portfolio at 20% which is the highest in the industry only on the back of its core strength in digital capabilities.


Digitally enabled open architecture: ICICI Securities

ICICI Securities adopted an open architecture system which allowed the company to source clients from other banks and at the same time have a complete end to end online digital on-boarding capability. This has helped the company to expand its canvass of offerings which can be sourced from multiple channels resulting into

· addition of 0.35mn (55% digital) clients last quarter as against 0.09mn in early 2020

· Incremental NSE client addition market share moved from 1% to 16% from early 2020 to Mar 2021

· Contribution from ICICI Bank for new customer acquisitions reduced from 81% to 45% from early 2020 to Mar 2021

Complete digital stack and many firsts – ICICI Lombard General Insurance:

· ICICI Lombard has a complete digital stack across a customer’s life cycle starting from purchase, managing risk, servicing, process claims and renewals.

· First to set an in-house digital arm – a virtual company called ICICI Lombard Digital to spearhead insurance services through a purely digital platform.

· Recent acquisition of Bharti AXA happened completely virtually


4. Customer culture transformation: 'Fair to Customer, Fair to Bank'


a. Customer suitability and centricity

In our first meeting Sandeep mentioned that he would stop selling all products which are not suitable for customers - What is not good for customer cannot be good for the Bank. He changed the entire focus on doing what’s right. A customer-centric approach with a focus on maximising the lifecycle value of the relationship with a customer was the key strategy. The principle of 'Fair to Customer, Fair to Bank' emphasising the need to deliver fair value to customers was the guiding philosophy.


Further digital initiatives were combined with customer centricity to make life easier. The concept of customer satisfaction has been replaced with ‘delight’.

b. Right set of products – ICICI Prudential Life Insurance:

Considering the importance of protection for the customer as well as to reduce cyclicality of ULIP, ICICI Prudential Life management chose to bring down the proportion of cyclical ULIP business in favour of the structural traditional business. Building traditional business (non ULIP) requires significant upfront investments and hence can be a drag in the initial years, however it is more sustainable as compared to ULIPs which is cyclical.

Contribution of ULIP to APE was down from 82% to 48% from 2018 to 2021, which has resulted in an overall de-growth but led to a significant improvement in persistency and profitability margins as measured by NBP margins.


c. Introduction of new products and increased customer engagement – ICICI Securities:


Brokerage - Prime, NEO and other plans:

We were pleasantly surprised when we met Vijay who was focussing on revamping the customer experience through technology. ICICIDIRECT.com’s need for investment in technology and processes was long overdue but was ignored for long paving way for competition.


ICICI Securities is now expanding its product offerings transforming itself from a capital market platform to a one stop shop for financial products. We believe this is a much-underappreciated journey.


First time ICICI Securities made open architecture which enabled them to deal with the customers from other banks too - a smart strategy to capture customers from other banks who had no capability nor focus on these services. But it required a big mindset change, which Vijay has steered well.


It also increased client engagement – so as to get maximum benefit out of existing customers for not only cross selling expanded bouquet of products as per their need but also activating clients who had been with them for long. This has led to

· An improvement in active clients proportion from 29% to 35% from FY 2019 to FY 2021

· NSE Active clients increased from 0.88mn to 1.58mn from FY 2019 to FY 2021 (1.8x in 2 years)

· Cross sell ratios (products per customer) improved from 1.60 to 1.78

· Activation of new customers improved from 34% to 84%


The above transformational changes have resulted in a significant improvement across various risk-return metrices like:

· Risk calibrated growth 2018 to 2021:

- ICICI Bank: Proportion of retail loans up from 57% to 67%, BBB down from 27.5% to 24%, GNPA down from 9% to 6%

- ICICI Prudential Life: ULIP proportion down from 82% to 48%

- ICICI Lombard: proportion of crop insurance brought down from 19% to zero

· Growth: Despite of the above calibrated approach, the Bank has delivered a credit growth CAGR of 13%

· The above has resulted in significant improvement to NIM, credit cost, combined ratio (ICICI Lombard), NBP margins and persistency (ICICI Prudential Life) leading to a first wave of rerating.


We foresee market cap of The ICICI Group moving up 5-6X from USD 80 bn to USD 400-500 bn in the current decade. Growth (Risk Calibrated) - 2018 to 2021

While all the subsidiaries have a strong business model per se and are independent, they provide a good hedge to the parent from cyclicality and at the same time add value to the overall parent profitability. Subsidiaries contribute about 30% to the overall profit of the Bank and have grown their profits at ~ 17% CAGR over a period of 2018 to 2021. Subsidiaries like AMC will further unlock value in the future once they get listed.


Profits from major subsidiaries (INR cr)

Carnelian IMPRESS framework:


Integrity:

“Look for three things in a person, Intelligence, Energy and Integrity. If they don’t have last one, don’t bother about the first two” - Warren Buffett


This is even more important when you are minority shareholder. We have seen many cases in the recent past. Yes! in the recent past, business and minority shareholders got destroyed due to lack of integrity and character.

Narayan Murthy, Azim Premji, Qimat Rai Gupta, exemplify the virtues of integrity in business - how they built empires despite challenging environments.


Modest and capable:

“Hubris, arrogance, is just one step ahead of loss of integrity, because if you think you're better than other people, you know more, then you're going to think, as many leaders have, that the rules don't apply to them - so they lose their integrity” - Charles Koch


We believe only modest and humble people in life have the humility to accept that they do not know everything and continuously learn and adapt. Modesty and capability go hand in hand. We have countess exemplars in front of us – R K Damani, Harsh Mariwala, Madhukar Parekh, N Chandrashekhar, etc.


Passionate & driven

Here we are reminded of Jack Welch’ 4E and One P framework. GE leadership team evaluated on 4E (Energy, Energise others, Edge & Execution) and one P (Passion).


Managements who are passionate, motivated and driven can take businesses really far, much beyond anyone’s expectation. They always deliver on raised expectations - Aditya Puri, Uday Kotak exemplify this well!


Realistic but aggressive:

“Expect the best, plan for the worst and prepare to be surprised” - Denis Waitley


Managements who are always going to deliver their best within a realistic framework are always managing both risk and reward. We don’t like managements who are only looking at one side of things. For examples Aarti Industries, Divis Laboratories, Astral Polytechnic etc.


Efficient Capital allocator

This is the one factor which can make a big difference in the investment outcome. Similar businesses, great brands but capital allocation decision can create a substantial difference in returns. HDFC Bank (6x) vs. ICICI Bank (1.7x) between 2008-2018, showcases the impact of this choice. One must select a leader with sound capital allocation framework and discipline. Other examples include ICICI Lombard, PI Industries, Supreme Industries, Pidi lite etc.


Skin in the game:

“No person in a transaction should have certainty about the outcome while the other one has uncertainty” - Nassim Nicholas Taleb


Management whose interest is aligned to both upside and downside of their own actions are usually best suited to create value. We prefer people who have a skin in the game - either monetary or non-monetary.


Strong Governance and Risk Management

“Governance and leadership are the yin and the yang of successful organisations. If you have leadership without governance, you risk tyranny, fraud and personal fiefdoms. If you have governance without leadership, you risk atrophy, bureaucracy and indifference” - Mark Goyder


This again goes back to our first point about integrity but organisational integrity. If all the above factors are present and the governance framework is poor, then minority shareholders will always be at the receiving end. Only strong governance & risk management builds check and protects against hubris, dishonesty, short term compromises and pressures. Best intentioned managers can fall prey to short term temptations and pressures in absence of strong governance framework.


Our own forensic analysis focusses a lot on this parameter to dig deeper to see potential compromises. We love managements with a high score on this.


If we get a high score on all these counts, we simply say “We are IMPRESSed”!!


Carnelian’ IMPRESS score card gives us a strong conviction around our belief that the right Ship led by the right captain with favourable tide will lead to strong wealth creation over a period of time.

On a concluding note, when we see a good business run by a motivated team, well-oiled organisational machinery with a wrap of right cultural set, we start salivating. The probability of success goes up, risk reward starts swaying favorably.


Our money is on this. We have invested in ICICI Bank and ICICI Securities as a part of our Magic Basket (as we see both an earnings growth and rerating) & ICICI Lombard in our Compounder Basket (where we see sustainable earnings growth). We have about 13.6% of our fund in the group and are happy investors so far.


We have an internal saying - “If there is a tailwind and you board the right ship with right the Captain, you can go really far”. The ICICI Group is that right ship under the command of a right Captain which can go far on a wealth creation journey of USD 400bn to USD 500 bn in the current decade (this is only a ~20-22% compounding ask). Our money is ON it.

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