HDFC Bank vs Bajaj Finance: Which Stock is Better?

When we think of getting a loan, we think of banks right away. But there are other kinds of financial companies too that contribute to enhancing the credit offtake in the system.

These financial companies include non-banking financial companies (NBFC), microfinance institutions (MFI), small finance banks (SFB), regional rural banks (RRBs), etc.

These companies along with scheduled commercial banks (SCBs) make up the Indian financial ecosystem.

When it comes to credit creation, banks are indisputable leaders. However, NBFCs have been recording higher credit growth in the last few years.

NBFCs are the largest borrowers for banks. In the last decade, NBFCs went from being 12% of banks' balance sheets in 2010 to over 25% today. That's phenomenal growth, isn't it?

So, if you had limited capital to invest in just one financial company, which one you should choose: A bank or an NBFC.

This article aims to answer this question through a detailed comparison of India's largest SCB and NBFC, that is HDFC Bank and Bajaj Finance.

Overview

Bajaj Finance is a deposit taking NBFC registered with the Reserve Bank of India (RBI). The company is in the business of lending and accepting deposits.

Bajaj Finance has a diversified portfolio comprising retail, SME, and commercial customers across urban and rural areas. The company offers products and services across six broad categories:

• Consumer lending
• SME lending
• Commercial lending
• Rural lending
• Deposits
• Partnerships and services

The company has two wholly owned subsidiaries, Bajaj Housing Finance (BHFL) and Bajaj Financial Securities (BFinSec).

The products and services offered via these two subsidiaries are an extension of its core products and services such as mortgages, margin facilities, etc.

The company has its operational presence in 3,329 locations in India. It had a customer base of 52.8 m as of 30th September 2021.

HDFC Bank is India's largest bank by market cap and the largest private sector bank by assets. The company offers a range of products and services to individuals, businesses, and institutions under three heads:

• Wholesale Banking
• Retail Banking
• Treasury Operations

HDFC Bank is one of the most valuable brands in India with a brand value of US$ 20.2 bn. Also, it's among the few companies listed on international stock exchanges.

Deposits

HDFC Bank and Bajaj Finance are engaged in the business of taking deposits and offering loans.

Therefore, cash is at the core of everything they do, it's the lifeline of their business. The more cash they have, the more credit they can give.

These companies tap into various sources of funding to ensure they never run out of funds. These sources include their own equity, debt market, and deposits.

From a cost perspective, deposits are the cheapest source of funds. Therefore, amplifying their deposit buffers is one of the top priorities for these companies.

Let's look at the deposit base of HDFC Bank and Bajaj Finance and its growth over the years.

HDFC Bank vs Bajaj Finance Deposits (2017-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Deposit (in Rs m )
HDFC Bank	6,431,342	7,883,751	9,225,027	11,462,071	13,337,209
Bajaj Finance	27,932	77,929	131,930	214,272	258,034
Deposit Growth (%)
HDFC Bank	17.8%	22.6%	17.0%	24.2%	16.4%
Bajaj Finance	84.0%	179.0%	69.3%	62.4%	20.4%

Source: Equitymaster

With just a glimpse you will notice that HDFC Bank's deposit base is higher than Bajaj Finance.

This enormous difference in deposit base exists because of the very nature of their business models.

HDFC Bank is a full-fledged bank. It accepts all types of deposits out of the box.

By all types of deposits, I mean demand deposits (saving account, current account), time deposits (FDs). The same is not true for Bajaj Finance.

Bajaj Finance is an NBFC. Generally, an NBFC is not allowed to accept any sort of deposit.

However, Bajaj Finance is an exception. The company has approval from RBI to accept deposits.

Now, even though the company accepts deposits, it's only limited to time deposits such as FDs. The company can't accept demand deposits.

This is one of the biggest differences between HDFC Bank and Bajaj Finance. It's perhaps the biggest reason which explains such a substantial difference in their deposit base.

The other reason is the time for which they have been accepting deposits. HDFC Bank has been accepting deposits since 1994 when it was established. Bajaj Finance, on the other hand, started accepting deposits much later.

Talking of growth, Bajaj Finance appears to be doing better than HDFC Bank. Bajaj Finance's deposit base grew at a CAGR of 56% over the last five years. During the same period, HDFC Bank's deposit base grew at a CAGR of 15.7%.

However, one must note that HDFC Bank's double-digit growth comes off on a higher base, which is commendable.

Advances

Bajaj Finance and HDFC Banks provide credit to individuals as well as businesses.

While Bajaj Finance is a leading financier for consumer durables, HDFC Bank is a leading player in the auto finance segment.

Also, HDFC Bank is the market leader in credit cards with a total market share of around 23%.

Let's have a look at the loan book of these players.

HDFC Bank vs Bajaj Finance Advances (2017-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Advances (in Rs m)
HDFC Bank	5,854,810	7,000,338	8,692,227	10,436,709	11,852,835
Bajaj Finance	320,282	791,025	1,125,128	1,413,761	1,466,869
Advances Growth (%)
HDFC Bank	19.4%	19.6%	24.2%	20.1%	13.6%
Bajaj Finance	29.2%	147.0%	42.2%	25.7%	3.8%

Source: Equitymaster

In absolute terms, HDFC Bank's loan book is 10 times that of Bajaj Finance. However, the latter's loan book is growing at a phenomenal speed.

Thanks to its interest-free EMI scheme, which provides consumers with a convenient way to pay for their purchases, Bajaj Finance's loan book has grown at a CAGR of 35.6% over the last five years.

HDFC Bank, on the other hand, has added loans at a CAGR of 15.1% during the same period.

Net Interest Margins

When you park your money with banks, they offer you interest. Banks do the same on the lending side too. The only thing is the interest rate charged to borrowers is higher than what is offered to depositors.

The difference between interest earned and interest paid, known as "spread" in technical parlance, is the core income of a finance company. This difference appears as Net Interest Income or NII on the P&L statement.

Rising NII is a sign of a healthy financial institution. Now, if NII is divided by the total value of loans disbursed then that gives us Net Interest Margins (NIM).

NIM is an important metric as it reflects the core operational efficiency of a finance company. Thus, higher the NIM, the better it is for investors.

So, let's see how HDFC Bank and Bajaj Finance did on this metric over the last five years.

HDFC Bank vs Bajaj Finance Net Interest Margin (2017-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net interest margins (%)
HDFC Bank	4.40%	4.60%	4.40%	4.20%	4.30%
Bajaj Finance	16%	9.80%	9.70%	10.50%	10.40%

Source: Equitymaster

HDFC Bank's average NIM for the last five years turns out to be 4.4%. This is compared to Bajaj Finance's average NIM of 11.2% during the same period.

The difference in NIM is due to different statutory requirements for both companies.

To avert any liquidity issues, these companies are required to invest a percentage of their total capital in liquid assets such as cash, gold, and g-secs. This is called the statutory liquidity ratio (SLR).

SLR for Bajaj Finance is 15% whereas it is 24% for HDFC Bank. This implies that Bajaj Finance has more money to lend compared to HDFC Bank.

Non-Performing Assets (NPAs)

The loans disbursed by a financial company can be classified into two: secured loans and non-secured loans.

Secured loans are provided against collateral. If the borrower fails to pay, the creditor (a financial company) could sell the collateral to recover the loan amount. A home loan is a classic example of a secured loan.

In the case of unsecured loans, there is no collateral to rely on. If the borrower fails to pay, then the company could either restructure the loan or write off from its book. An example of unsecured lending is a loan for purchasing consumer durables as Bajaj Finance does.

Bajaj Finance and HDFC Bank, being large financial institutions, have a substantial portfolio of unsecured loans. They run the risk of losing that money if the borrower fails to pay them back.

If a borrower is overdue on his payments for more than 90 days, then that loan becomes a non-performing asset for a financial company.

NPAs beyond a certain limit could cripple a financial company.

Let's look at the NPA numbers of Bajaj Finance and HDFC Bank.

HDFC Bank vs Bajaj Finance Net NPAs over the Years

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net NPA (%)
HDFC Bank	0.3%	0.4%	0.4%	0.4%	0.4%
Bajaj Finance	0.4%	0.4%	0.6%	0.8%	0.9%

Source: Equitymaster

HDFC Bank's NPA for the last five years averages at 0.4%. It means that if HDFC Bank disburses a total loan of Rs 100 then Rs 0.4 doesn't come back to the bank.

During the same period, Bajaj Finance's NPA averaged0.6%.

NPAs of these companies are among the lowest in the industry. This tells us how good these companies are at assessing risk.

These companies have a strong risk assessment framework that helps them to screen high-quality borrowers. This remains one of the biggest competitive advantages for these companies and gives them an edge over their competitors.

Net Profit Margins

Now let's talk about the profits each company has been generating over the last five years.

The following table shows the net margins of HDFC Bank and Bajaj Finance over the last five years.

HDFC Bank vs Bajaj Finance Net Profit Margins (2017-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net profit margins (%)
HDFC Bank	20.8	21.7	21.2	22.3	24.8
Bajaj Finance	18.4	19.5	21.6	20	16.6

Source: Equitymaster

HDFC Bank scores a point here. HDFC Bank has clocked an average margin of 22.2% over the last five years. During the same period, Bajaj Finance has clocked an average margin of 19.2%.

What's more interesting is that HDFC Bank has been reporting higher margins every passing year. This is due to the lean operating costs of the bank.

On top of that, HDFC Bank's brand value allows it to raise capital at lower rates thereby reducing its overall costs.

Dividend Payout

HDFC Bank and Bajaj Finance are leading lenders in their respective segments.

The scale at which they operate allows them to generate enough cash to share it with their shareholders.

These companies have rewarded their shareholders with dividends consistently over the last five years.

The following table shows the dividend profile of HDFC Bank and Bajaj Finance for the last five years.

HDFC Bank vs Bajaj Finance Dividend data (2017-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Dividend per share
HDFC Bank	5.5	6.5	7.5	2.5	6.5
Bajaj Finance	3.25	3.8	5.72	9.91	9.94
Dividend Payout Ratio (%)
HDFC Bank	9.2	9.1	9.1	5	11.3
Bajaj Finance	10.7	9.2	8.7	11.4	13.6

Source: Equitymaster

HDFC Bank has paid an average dividend of Rs 5.7 per share in the last five years. This along with an average dividend payout ratio of 8.7%.

Bajaj Finance, on the other hand, has paid an average dividend of Rs 6.5 over the last five years along with an average dividend payout ratio of 10.7%.

Clearly, Bajaj Finance has been paying higher dividends.

Operational Presence

Bajaj Finance has an operational presence in 3,329 locations across the country. The company sells its products and services via physical points of sale present. It serves52.8 m customers via 119.900 physical points of sale across the country.

In addition to its physical network, the company has been strengthening its digital channels for the tech savvy. The company has been developing a super app to serve all the financial needs of its customers.

As of March 2021, HDFC Bank had a total of 21,364 banking outlets across the world. Besides banking outlets, the company operates an all-in-one payments app called "Payzapp".

Return and Valuation Ratios

When comparing two financial companies, analysts usually use three ratios to find out which is undervalued. These three ratios are return on equity (ROE), return on assets (ROA), and price to book value (P/BV).

Return on equity (ROE) tells an investor how much profit a company generates on shareholders' capital. It is expressed in terms of percentage.

Return on assets (ROA) tells an investor how much profit a company generates on total assets the company owns.

A crucial point to note is loans are assets for banks and ROA is calculated as a ratio of net income to its total performing (generating interest income) assets. For banks, ROA of 1% is a benchmark and anything beyond that is considered excellent.

Price to book value (P/BV) indicates the price an investor is willing to pay for each rupee of a company's book value.

HDFC Bank vs Bajaj Finance Return and Valuation Ratios (2017-2021)

	ROE	5-year average ROE	ROA	5-year ROA	P/BV	5-year average P/BV
HDFC Bank	15.2	15.7	1.8	1.7	3.2	3.5
Bajaj Finance	12.1	16.8	2.6	2.9	10.7	6.9

Source: Equitymaster

Bajaj Finance has performed better than HDFC Bank on return ratios. This is the reason why Bajaj Finance trades at a higher price to book (P/BV) multiple as compared to HDFC Bank.

Impact Of Covid-19

The Covid-19 pandemic was a minor blip in the growth journey of HDFC Bank and Bajaj Finance.

These companies experienced a slowdown in the first two quarters as they exercised extreme caution.

Bajaj Finance in specific had to tread cautiously as NBFCs were required to offer moratorium services to their borrowers while not getting the same service for themselves. NBFCs are the largest borrowers of banks.

If looked at the brighter side of things, the pandemic accelerated the digitisation efforts of these companies. HDFC Bank and Bajaj Finance strengthened their digital infrastructure to strengthen its customer engagement, collection process, and product distribution.

These companies saw signs of recovery from third quarter onwards. On the retail front, home loans lead from the front. In the wholesale segment, these companies financed the working capital requirement of businesses.

Future Prospects

A large part of India is still credit averse. India's total outstanding loans to gross domestic product (GDP) is just 15% compared to 80-100% in its western counterparts.

So, India has got a lot to cover and there is a lot of headroom for growth for HDFC Bank and Bajaj Finance.

Which channel would drive growth for these companies?

Both companies unequivocally agree that the future is digital.

Therefore, they have been investing in building digital channels either through in house development or through partnerships with fintechs.

Bajaj Finance has been in the process of developing a super app to serve all the financial needs of a customer. The company aims to streamline all its processes right from origination to collection, thereby reducing the costs.

HDFC Bank entered into a strategic partnership with Paytm to leverage Paytm's digital platform and expand its reach in rural markets where Paytm enjoys good rapport with small merchants.

As far new areas of growth are concerned, Bajaj Finance is eyeing the healthcare industry. It has brought the concept of no cost EMI to the healthcare industry and aims to taste the same success it had with consumer durables.

HDFC Bank, on the other hand, has announced its merger with its parent company, HDFC Ltd. This merger would result in a financial behemoth worth US$ 160 bn.

HDFC Bank would benefit from this merger in two ways.

First, the bank would inherit all the customers associated with HDFC Ltd at no extra cost. This means more business for the bank as it can cross-sell various products to these customers.

Second, the bank would be able to raise fresh capital at a lower rate which can be then passed to its potential customers. This would give the bank an edge over its competitors.

Which is Better?

From the above discussion, Bajaj Finance leads the way on almost all metrics except for NPA and net profit margins.

However, the company's phenomenal growth has been accounted for in its share price. That is why it trades at a premium valuation than HDFC Bank on P/BV multiple.

HDFC Bank's performance is commendable, given its large book size. HDFC Bank is trading at a lower P/BV multiple than Bajaj Finance.

So, HDFC Bank is relatively undervalued here.

Though this article might have made things easier for you, we strongly recommend you check the fundamentals and valuations of both these companies on your own.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...