HDFC Bank - Business as usual continues to trade at premium valuation - K R Choksey

We met the management of HDFC Bank to understand macro environment and medium term business strategy. Key highlights of our discussion are as under:

Business continues to grow premium to the sector: Loan book and Deposits grew 22.2% & 18.3% in FY12. Retail loan book outpaced the corporate loan book mainly due to tactical move to rundown of wholesale book and strong underlying drivers in retail space. The bank continue to witness strong growth in Auto loans, CVs and business banking segments driving retail loan book growth. The management expects retail loans to continue to grow faster than corporate loans in FY13. Corporate loan book is likely to see some pick up in H2FY13. Corporate sales held up well which in turn drive working capital demand in the system. We expect loan book to grow 20% CAGR over FY12-FY14 and NII to grow 18.9% CAGR driven by 20% CAGR in loan book & stable margins.

Regulatory changes in MFs & Insurance have slowed down fee income growth: Core fee income increased 18.9% in FY12. Retail and corporate segment contribute 80% and 20% respectively to total fee income. Lower commission on traditional insurance products and tepid volume growth were primary drivers for subdued retail distribution fee income. The management expects ~ 17-18% growth in core fee income supported by retail business and revival of corporate fees in FY13. Forex income grew strongly 37.4% y-o-y in FY12 on the high volatility in rupee. We believe stability in rupee may result into slow down forex fee income going forward.

Branch addition run rate will slowdown in FY13 - HDFC Bank has added 558 branches in the last year. Broadly newly open branches start to contribute to profitability in two years from the commencement. The management is confident to maintain ~ 47-48% CASA levels in medium term. In addition to this, the bank plans to add 250-300 branches per year in next 3-5 years which will support CASA mobilization strategy & priority sector requirements.

Overall asset quality stable - HDFC bank's asset quality trend continues to relatively stronger in challenging macro environment largely attributable to benefits of CIBIL ratings, stringent credit origination practices after global financial crisis in retail sector, high wage inflation. Average credit costs have been ~ 156bps over FY07-FY11, which went down further to 37bps in FY12, lowest in the bank's history. We believe superior retail portfolio behaviors and lowest credit costs behind us and overall credit costs is likely to increase in next few years from FY12 levels , so we are factoring in 80bps and 90bps credit costs in FY13 & FY14 respectively against 37bps in FY12.

BASEL III & Dynamic Provision norms: The bank has core tier I at 11.52% well above the requirement under BASEL III. Moreover, the bank has provided Rs700 crore towards floating provision as counter cyclical buffer in FY12. Overall the bank is well positioned to comply with new norms under BASEL III & Dynamic Provisions.

Valuation & Recommendation

We believe superior risk adjusted margins, strong earnings visibility (18.9% CAGR over FY12-FY14), superior return ratios, impeccable asset quality and strong CASA ratios are key value drivers for the stock. At Rs 546 the stock is quoting at 3.3x FY14e adjusted book and 17.5x FY13e earnings, we believe strong business model and higher earning visibility deserve premium valuation. We have revised our target price to Rs592 due to roll over to FY14 estimates. We maintain HOLD rating on the stock with target price of Rs592.

Source : Equity Bulls

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