Weekly Tactical Pick: Why you should back this private sector bank behemoth now.
Given HDFC Bank’s track record and execution capabilities, it can positively surprise the Street on earnings growth in the next fiscal.
The stock of HDFC Bank (CMP: 1,650; Mcap: 12,52,273; Nifty: 21,183) has rallied 11 percent in the last month but has significantly underperformed its peer (ICICI Bank) and the sector benchmark year-to-date (YTD). While the Bank Nifty delivered an 11 percent YTD, HDFC Bank moved up just 1 percent in the same period.
Obviously, the merger has weighed on the HDFC Bank’s stock performance.
Earnings growth moderate post the merger
HDFC Bank’s EPS (earnings per share) in the first quarter after the merger (Q2 FY24) grew 10 percent YoY compared with the corresponding quarter last year (Q2 FY23), reflecting the effect of the merger.
HDFC Bank, known for its consistency, had delivered an earnings growth of 30 percent YoY every quarter for a very long period and that moderated to 20 percentYoY in the past few years. Because of this consistency across credit cycles, HDFC Bank enjoyed a premium valuation.
However, HDFC Bank’s profit growth in Q2 FY24 was dragged down by a sharp contraction in margins despite healthy business growth.
Post the merger, the largest private bank’s gross advances increased by around Rs 1.1 lakh crore as of end September’23 compared with June’23. This translates into an advances growth of 4.9 percent in a quarter, implying an annualised run-rate of around 20 percent which is very healthy.
Similarly, HDFC Bank’s deposit growth of 5.3 percent in Q2 FY24, if extrapolated, translates into an annualised growth of more than 20 percent.
However, HDFC Bank reported an NIM (net interest margin) of 3.4 percent in Q2 FY24, much lower compared to 4.1 percent pre-merger. Margins took a knock due to the excess liquidity carried by erstwhile HDFC and the incremental CRR that was imposed by the RBI.
Valuation attractive, concerns priced in
The two main concerns of the Street are the sustainability of growth on a bigger balance sheet and profitability amid rising regulatory costs and margin decline post the merger.
If one goes by the business performance of Q2 FY24, growth is unlikely to disappoint much even on a large balance sheet. If the current pace is sustained, HDFC Bank will double its balance sheet in four to five years.
Now coming to the earnings growth, margins are expected to improve gradually. The NIM will remain below the pre-merger level in the near term as the merger has led to a shift in the loan-book mix in favour of mortgages that earn lower spreads. However, in the medium term, replacement of erstwhile HDFC’s market borrowings on maturity with bank deposits will lead to cost benefits on the funding side and improve margins.
Also, the operating leverage (cost-to-income ratio) could improve in the long term and offset the increased regulatory drag.
Despite lower margins and other merger-related hiccups, profitability was maintained as the bank delivered an ROA (return on assets) of 2 percent and an ROE (return on equity) of 16 percent in Q2 FY24. The management reiterated that the bank will deliver an ROA of 1.9-2.1 percent in FY24.
While the earnings growth has come off, HDFC Bank’s valuation too has moderated. This implies that merger-related uncertainties are already in the price.
In terms of valuation, HDFC Bank is now trading at 2.1 times the core book value of the merged entity estimated for FY25 after adjusting for the valuation of subsidiaries.
It will take at least a couple of quarters to clearly assess the long-term profitability of the merged entity. But given the bank’s track record and execution capabilities, HDFC Bank can positively surprise the Street on earnings growth albeit in the next fiscal which can lead to a valuation re-rating and stock upside.
Investors should consider the underperformance as an opportunity to accumulate this steady compounder.
Bymoneycontrol
