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HDFC Bank (HDFCB)
Banks/Financial Institutions
Franchise value to get more meaningful in current times; upgrade to ADD. HDFC
Bank is best positioned at times of tight liquidity and higher rates, on the back of its
superior liability franchisee. Even as valuations remain expensive, superior growth and
low risk makes us more positive on the stock. We believe that above-industry loan
growth (25%+), 4%+ margins and lower provisioning should drive 30% PAT growth
over the next few quarters. Upgrade to ADD (from REDUCE) with a TP of `2,500.
Upgrade to ADD; premium valuations to continue
We upgrade HDFC Bank to ADD post the recent correction. The stock has underperformed Sensex
by 12% over the past 3 months and 8% over the last month. Despite the bank trading at
premium valuations of 20X PER and 3.5X FY2012E PBR, we believe that the above-average
business growth and declining credit costs would enable the bank to deliver 28-30% earnings
growth over the medium term and expect higher valuations to sustain. We see limited margin
impact as the benefit of strong CASA ratio cushions the rise in deposit rates. HDFC Bank is one of
the best banks to own in such an environment given its strong core liability franchisee; upgrade to
ADD. Our TP of Rs2,500 remains unchanged.
Lower credit costs and strong business performance to drive earnings growth
We are building earnings to grow by 30% CAGR in FY2010-12E on the back of strong business
growth and sharp decline in loan loss provisions. We are impressed by HDFC Bank’s recent
operational performance—excelling on all key parameters. Margins have been maintained at 4.2%
levels in many quarters despite a volatile interest rate cycle. Loan growth continues to remain
above-industry average while NPL ratios have declined sharply resulting in lower credit costs.
Quality of earnings has improved considerably as earnings are being driven by core performance
with negligible treasury income.
CASA ratio at 50% to cushion the impact of rising deposit rates
With interest rates firmly rising in recent quarters on the back of tight liquidity environment, the
power of CASA franchisee is likely to be reflected in the resilience of its margins and strong pricing
power of its loan portfolio. CASA deposit growth has been spectacular with savings deposits
growing by 38% yoy to `595 bn and current deposits growing by 22% yoy to `394 bn as of
September 2010 – one of the best in the industry. Over the past one year, CASA ratio has
consistently averaged at 50% (average CASA near 45%) and we expect the bank to maintain it at
current levels. We see limited downside to our margins from current levels.
Loan growth to remain higher than industry
The management has highlighted their strategy of growing loans by 3-5% higher than
industry growth on a normalized basis. 1HFY11 witnessed higher-than-industry loan growth
at 38% yoy as it benefitted from an opportunistic lending in telecom etc. We are building
loan growth at 28% CAGR for FY2010-12E. Barring interest rates, we see limited headwinds
in most of the segments that the bank is present. Retail business continues to grow at a
healthy pace while the buyback of mortgages from HDFC will sustain loan growth at current
levels. Also, with improvement in economic activity there are sufficient opportunities to
grow at a rapid pace for project-related activities, an area where HDFC Bank is seriously
looking to enter but mainly for its internal clients having focused on working capital related
business in the past. We believe that the proportion of mortgages and project-related loans
will increase over time although retail and working capital loans will continue to dominate
its loan book.
Credit costs to remain low in this phase of credit cycle
We are building credit costs to decline to 1.2% in FY2011E and 1.1% in FY2012E as NPLs
have been stabilized, underwriting in the past 6-8 quarters have been fairly stringent, and
current outlook on business activity and savings levels continues to remain strong. Retail and
corporate NPL should witness lower incremental delinquencies. The bank historically has
been providing about 200 bps loan loss provisioning, which we expect to decline now, also
aided by the fact that loan book composition is changing towards more secure assets.
HDFC Bank has managed its asset quality in the best possible manner by sustaining its net
NPLs currently at 0.3% and gross NPLs at 1.2%. The total restructured assets for HDFC Bank
are just at 0.3% of the loan book
Cost-income ratio maintained at current levels
Cost-income ratio has been maintained at 48% levels, levels that the bank had seen preCBoP merger. We expect cost-income ratios to be maintained at closer to current levels
despite business witnessing some shift to higher duration low-risk products like housing
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