HDFC Bank (HDBK.BO) Strong Fundamentals but Valuations Limit Upsides Citi

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HDFC Bank (HDBK.BO)
Strong Fundamentals but Valuations Limit Upsides
 Lowering Target Price to Rs500, Maintain Hold — We reduce our EVA-based
target price to Rs500 benchmarked to 3.5x 1Yr Fwd P/BV from 3.75x. HDFC
Bank remains fundamentally the least impacted in the current macro slowdown
and has meaningfully outperformed the banking sector (+18% outperformance to
Bankex in the last 6months). We believe it should continue to outperform near
term, especially if overall macro deteriorates further. However, its strong relative
valuation premium will also limit upside from current levels.
 Robust balance sheet, strong asset quality — HDBK’s balance sheet remains
robust – a) Loan growth has been healthy (+25%yoy), exposure to vulnerable
segments remains low and outlook largely stable; b) Deposit mix remains strong
with CASA at 49%; c) Asset risks lowest relative to peers – low NPLs, reducing
slippages, low credit costs and restructured assets; and d) Comfortable capital
with Tier 1 at 11.4%. Overall, a steady franchise with consistent growth, quality
and return outlook.


HDFC Bank
Company description
HDFC Bank, which began operations in 1994, is 23%-owned by HDFC - India's
premier mortgage-finance institution. HDFC Bank has a network of more than 2,100
branches and more than 4,230 ATMs in 779 cities. HDFC Bank has had strong and
steady growth over the past 10 years and continues to grow at more than 25%.
HDFC Bank acquired Times Bank in 2000 and Centurion Bank of Punjab in 2008.
This has made HDBK the second-largest private sector bank in India, by a relatively
large margin.
Investment strategy
We rate HDFC Bank as Hold/Low Risk (2L) with a target price of Rs500. HDBK has
now been through a couple of business cycles, and has distinguished itself
consistently. While we believe its relative value is most obvious in challenging times,
its current valuations are close to the peak they will likely generate in this cycle, and
we expect stock returns will be modest from current levels. We expect HDFC Bank
to trade in the 3-4x P/BV band over the longer term, the middle of its long-term
trading band. Any valuation upside from here would depend on a sustained ROE
improvement outlook (20%+), or a particularly favorable macro-environment, which
we do not foresee in the near term. We are positive on the bank's prospects and
management's ability to deliver, and believe it stands out relative to peers in the
currently challenging environment.
Valuation
Our target price of Rs500 is based on an EVA model, assuming a loan-loss ratio of
100bps, a long-term cost/income ratio of 42% and a spread of 310bps. We use the
EVA model as our standard valuation methodology for the India banking universe as
it dynamically adjusts the economic value of the business. As a secondary
benchmark, we apply 3.5x 1 year forward P/BV (Sep 2012) for a fair value of
Rs502. A 3.5x P/BV is a premium to almost all other Indian commercial banks, but is
justified, we believe, by HDBK's structurally higher margin, de-risked earnings and
balance sheet mix, as well as by gains in the consumer-lending franchise. This
multiple is in the middle of its PBV multiples in previous cycles.
Risks
We rate HDFC Bank as Low Risk based on our quantitative risk-rating system,
which tracks 260-day historical share-price volatility. The downside and upside risks
to our target price lie in: (1) any negative/positive news on asset quality; (2)
potential management changes; (3) emergence of high quality and scale
competitors; and (4) changing risk perceptions of private banks. If any of these
factors has a greater impact than we expect, the stock could have difficulty
achieving our target price.