On the 30th of November, as the stock markets rallied and closed at a historical high, one of the forerunners was HDFC Bank (52-week high levels). While the markets as a whole seem to have turned positive on banking stocks off late, it would be wiser to analyse whether fundamentals support the price.
HDFC Bank has been consistent in taking proactive steps to address several critical issues:
Growth in net revenues: HDFC Bank has shown consistent growth of more than 30% in revenues over the past few years. The revenue growth has been backed by a strong growth in both the net interest income (24.4%) and the fee income (42.3%). The growth in advances has been led faster rise in retail portfolio (40% of advances in FY04). Moreover compared to the other banks, HDFC Bank is less dependent on trading profits and this has insulated it from the recent rise in interest rates. The bank has transferred Rs 30 bn of government securities to the HTM category and has already taken the loss in the P&L account. Hence, the bank will also be insulated from providing mark-to-market losses on its portfolio in the coming quarters.
Quality of growth is good: The bank has been successful in arresting the incremental delinquency rates by adopting more conservative loan loss provisions than the regulatory requirements (in FY04 87% of the gross NPAs were provided for). The bank continues to maintain the lowest Net NPA / Advances ratio in the industry (at 0.2% of advances). We expect the bank to maintain such low NPA levels in the future as well.
Spreads getting thinner: The bank has more than compensated the 41 basis points fall in yield on advances (i.e. the rate at which the bank lent loans) by bringing down the cost of deposits by 150 basis points in FY04. The bank needs to expand its network aggressively to maintain higher growth in deposits and ensure that the spreads are maintained. As compared to FY98, the difference between yield on advances and cost of deposits has steadily narrowed. This is because of two reasons. One, the decline in interest rates has been very sharp between FY98 to FY04, both on the corporate as well as on the retail portfolio. With PLR (prime lending rate) no longer relevant for ‘AAA’ corporates, the bargaining power of banks have fallen. We believe that the current spreads are in line with few global banking majors. We expect spreads to remain under pressure in the medium-term.
But prospects are good: Going forward, with non-food credit growing at a faster pace, we believe that the corporate demand for credit will increase. Though HDFC Bank may not be the lead beneficiary from the investment recovery in the economy, we believe that the bank is well placed to capitalise on the long-term growth opportunities, primarily arising from increased retail credit penetration and select aspects on the corporate side.
The stock is currently trading at Rs 429 implying a price to book value multiple of 4.3 times our FY05 estimates. The price to earnings multiple stands at 21.3 times our FY05 estimates earnings, as against the Sensex P/E of 16.6 times trailing twelve months earnings. One of the key reasons for the same has been the bank’s ability to grow consistently and more importantly, without compromising on the asset quality. In this context, how long will such premium valuations be sustained remains to be seen? This is a negative in one sense.
The bank has plans to raise capital through an ADS issue to the tune of US$ 300 m, which will enable the bank to fund its expansion plans. The book value is likely to increase post the ADS issue (along with earnings dilution).
HDFC Bank declared the results for the third quarter of financial year ending March 2017 (3QFY17). The bank has reported 18% YoY and 15% YoY growth in net interest income and net profits respectively in 3QFY17.
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