Edelweiss: : maintain ‘HOLD’ on HDFC

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􀂄 Momentum intact: 30% plus PAT growth; quality continues to improve
In Q2FY11, HDFC Bank (HDFCB) delivered 32.7% profit growth (with continued
improvement in earnings quality). Core earnings came in strong, higher-thanexpected
loan growth (38% Y-o-Y: 32% core advance growth), steady operating
efficiencies and, most importantly, stable loan loss provisioning charge (reducing
dependence on treasury gains). Best-in-class asset quality was sustained with
gross NPLs reined in at 1.16% and NNPLs at 0.3%. The pace of low-cost deposit
accretion was stellar (31% Y-o-Y and 10% Q-o-Q). We believe the intrinsic
profitability during the quarter was higher than the reported 32.7% as
management utilised the strong earnings to make higher contingent provisions
towards floating provisions.
􀂄 Asset quality continues to improve; LLP at 1.2%
The bank’s gross NPA ratio declined 5bps Q-o-Q to 1.16%. However, GNPA
(absolute) grew 2.8% Q-o-Q to INR 18.6 bn. Credit cost averaged 1.22% (includes
floating provisions of around INR 1.5 bn), much lower than 1.7% posted over the
past five quarters, bolstering core profitability. Our interaction with management
indicates that incremental delinquencies in retail book continued to remain low
(cheque bounce rate, lead indicator of retail slippages, continues to remain down),
whereas there has been a marginal pick up in the wholesale book. We believe
credit cost can hold on to around 1.3%—a key trigger for RoA improvement.
􀂄 Outlook and valuations: Rich; maintain ‘HOLD’
Quality of HDFCB’s earnings continues to improve on the back of stable margins,
strong loan book growth, and declining provisioning pressure. With current gross
stressed assets (restructured + NPA) at 1.46%, the lowest in the system, the
bank is best placed to play the upcycle in growth as it carries limited baggage on
asset quality. The stock is trading at rich valuations of 3.8x FY12E adjusted book
and 21x FY12E earnings. We believe the bank has hit a sweet spot—strong
growth and lower credit cost—which will enhance return ratios {RoAs to a new
high of ~ 1.7% (FY06-10 average: 1.5%) and ROEs to ~20% by FY12E} and
support current multiples. We maintain ‘HOLD’ on the stock and rate it ‘Sector
Performer’ on relative return basis.