HDFC Bank (HDFCB IN) 4Q FY14: In-line numbers; asset quality improved ::JPMorgan

HDFC Bank (HDFCB IN) 4Q FY14: In-line numbers; asset quality improved		Overweight Price: Rs727.55 22 Apr 2014 Price Target: Rs800.00 PT End Date: 31 Mar 2015

HDFC Bank reported in-line PAT of Rs23.3B, up 23% y/y for 4Q FY14. Credit costs declined sharply, as NPLs started to flatten, driven by some improvement in the CV book. Margins improved sharply, although asset growth was somewhat muted at 23%. HDFC Bank remains one of our top picks in the sector, given the improving quality of earnings and strong balance sheet. The stock trades at 16.2x P/E (FY15E), below the long-term average. Given the sustained EPS compounding, we see this as a good entry point.

Table 1: 4Q FY14 result

Rs MM, YE Mar.	4Q FY13	3Q FY14	4Q FY14	YoY	QoQ
NII	42,952	46,348	49,526	15.3%	6.9%
Non-int inc	18,036	21,483	20,014	11.0%	-6.8%
Opex	31,362	28,951	31,747	1.2%	9.7%
PPOP	29,627	38,880	37,793	27.6%	-2.8%
Provisions	3,005	3,888	2,861	-4.8%	-26.4%
PBT	26,622	34,991	34,932	31.2%	-0.2%
Tax rate	7,723	11,734	11,667	51.1%	-0.6%
PAT	18,898	23,257	23,265	23.1%	0.0%
NIMs	4.50%	4.20%	4.40%	-0.10%	0.20%
ROA	2.04%	2.21%	2.05%	0.01%	-0.16%
Cost - Income	51.4%	42.7%	45.7%	-5.8%	3.0%
Tax rate	29.0%	33.5%	33.4%	4.4%	-0.1%
Balance sheet
Loans (Rs bn)	2,397	2,967	3,030	26.4%	2.1%
Deposits (Rs bn)	2,962	3,492	3,673	24.0%	5.2%
CASA Ratio	47.4%	43.7%	44.8%	-2.6%	1.1%
Asset Quality
Gross NPA	23,346	30,178	29,893	28.0%	-0.9%
Net NPA	4,690	7,973	8,200	74.9%	2.8%
Gross NPA (%)	0.97%	1.00%	1.00%	0.03%	0.00%
Net NPA(%)	0.20%	0.30%	0.30%	0.10%	0.00%
Credit cost	0.50%	0.55%	0.38%	-0.12%	-0.17%
Non-interest income	18,036	21,483	20,014	11.0%	-6.8%
Fees	13,826	15,750	15,212	10.0%	-3.4%
Forex	2,014	3,332	2,521	25.2%	-24.3%
Treasury	649	509	333	-48.7%	-34.6%

Source: Company data, J.P. Morgan calculations.

· Asset quality. Credit costs fell 17bp q/q to 38bp in the quarter. Gross NPLs were flat q/q and provision coverage remained robust at 73%. HDFCB’s asset quality has largely held up through the slowdown except for some pain on its CV book. That book is now stabilizing; management reiterated that the 3Q trend continued in terms of the overall momentum remaining stable.

· Loan growth. Loan growth was steady at 26% y/y, with retail loan growth far slower at 10% y/y. The retail-wholesale mix was distorted by sell-downs last year and the FCNR book, which was a large step forward. Management continued to guide that loan growth would be slightly above system, and any significant acceleration would depend on the economy.

· Margins and CASA. Margins moved up q/q on the back of falling funding costs. This more than offset loan yield pressures – high-yield segments are growing more slowly than the rest of the book. March-end CASA deposits spiked 1.1% q/q – management clarified that the growth in average CASA was more muted, albeit still quite strong. Fee growth continued to be under pressure, largely due to contracting distribution volumes of third-party products.

Table 2: DuPont analysis

YE Mar.	1Q FY13	2Q FY13	3Q FY13	4Q FY13	1Q FY14	2Q FY14	3Q FY14	4Q FY14
NIM	4.56%	4.58%	4.47%	4.64%	4.61%	4.55%	4.41%	4.37%
Fees/Assets	1.97%	1.86%	2.01%	1.88%	1.80%	2.05%	2.00%	1.74%
Net revenues/Assets	6.61%	6.32%	6.64%	6.59%	6.61%	6.42%	6.45%	6.14%
Operating Expense/Assets	-3.28%	-3.17%	-3.13%	-3.39%	-3.17%	-2.98%	-2.75%	-2.80%
Provisions/Assets	-0.73%	-0.46%	-0.45%	-0.32%	-0.55%	-0.39%	-0.37%	-0.25%
ROA	1.77%	1.84%	2.09%	2.04%	1.92%	2.01%	2.21%	2.05%

Source: Company data, J.P. Morgan calculations.

Figure 1: Strong growth in year-end CASA balances

Rs in billions, year-end March

Source: Company data.

Figure 2: Proportion of wholesale loans is steadily rising

Year-end March

Source: Company data.

Figure 3: Margins improved due to lower funding costs

Year-end March

Source: Company data.

Figure 4: Incremental retail loan growth is slowing due to lower Auto/CV loans

Rs in millions, year-end March

Source: Company data.

Figure 5: Credit costs trending down

Year-end March

Source: Company data, J.P. Morgan calculations.

Investment Thesis

We are OW on the stock, as:

1. We believe HDFC Bank is the best defensive bank stock in the current environment given what we believe to be its stable margins, healthy asset quality, consistent performance, and superior management.

2. The strong rural push is likely to deepen the liability franchise further and could be a significant advantage in the longer term with significantly lower COF for the bank. We expect earnings growth to remain strong, driven by strong revenue income and stable asset quality.

3. We believe the current valuations are reasonable in the context of high return ratios and consistency in performance for the bank across cycles.

Valuation

Our Mar-15 PT for HDFCB of Rs800 is based on a three-stage Gordon growth model, implying 3.7x FY15E book. Our valuation factors in a cost of equity of 15.0%, normalized ROE of ~26%, and a terminal growth of 5%.

Risks to Rating and Price Target

1) Slowdown in the retail segment, given the weak economy, and intensifying competition could affect loan growth for the bank in the medium term. 2) Product-specific shocks could result in a negative surprise on credit costs.

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