HDFC Q2 results came largely in line with our expectations. The results did not have any material surprise to lead us to change our Hold rating on the stock. With loan growth in mid-teens and NIM coming under pressure, we see valuation as stretched. We roll over earnings and up price target to R1,280. Retain Hold.
AuM growth flat, on balance sheet loan growth improves marginally: AuM growth remained flat, up 16.5% y-o-y, vs 16.4% seen in FY16. Individual loan book grew 16.9% y-o-y. Loans sold in Q2FY17 were R19.4 bn, below R28.6 bn sold in Q2FY16 and R51.1 bn sold in Q1FY17. Despite the lower off-balance sheet transfer of loans, on balance sheet loans grew at moderate 15.7% y-o-y.
Margins remain weak, funding mix moves towards bonds: NIM improved sequentially to 3.9% (+10 bps q-o-q and -20bps y-o-y) – very seasonal for HDFC – near the lower end of the range seen in the last 20 quarters (3.65%-4.66%). On y-o-y basis, calculated cost of funds was down 69 bps, whereas the calculated yield was down 68 bps. Core profitability growth improved. Core PPOP grew 14.0% y-o-y to R21.7 bn and was in line with JEFe. Net interest income grew 14.5% y-o-y, mainly driven by 15.7% y-o-y loan growth, offset by slightly deteriorating margin. Non-interest income for Q2FY17 was up 51% y-o-y on good core fee and increased dividend income. However, sequentially non-interest income was down 40% as Q1FY17 included gains from the sale of HDFC Ergo stake. Funding mix moved away from term-loans sequentially, and towards bonds, debentures, Cps.
Asset quality slightly worsened, credit cost returns to normal run rate: Non-individual loans GNPAs at 111 bps were flat q-o-q and y-o-y (111 bps in Q1FY17 and 112 bps in Q2FY16). Individual loan NPAs (61 bps) worsened slightly both y-o-y (53 bps) and q-o-q (59 bps). Total gross NPA was 76 bps, up 5 bps y-o-y and 1 bps q-o-q. Net NPA was 54 bps, up 4 bps y-o-y and down 1 bps q-o-q. In Q2FY17 the credit cost returns to its normal run rate and was 13 bps.
Tweaking estimates: We have adjusted our estimates to reflect our expectation of slightly lower NIM leading to lower NII. However, we expect higher non-interest income (treasury gains) to offset this decline in NII. Overall we increase our FY17-18E profit by 2%. We expect loan growth of ~18% but at lower spreads resulting in FY16-19E EPS CAGR of 6.4%.
Valuation/Risks: HDFC trades at 5.7x BV (Sep 16, not grossing for unrealised gains) and 28.7x EPS (12 m Sep 17E) versus 10 year average of 5.4x and 23.9x respectively. We value HDFC at 5.1x BV (Sep 17E) and 25.6x EPS (12 m Sep 18E). Downside risk: Weak volumes, asset quality worries.
AuM growth flat: AuM growth remained flat, up 16.5% y-o-y, vs 16.4% seen in FY16. HDFC Bank is now buying back a larger share of loans it originates (up to 70% from 50% in FY15). For origination, HDFC Bank charges a 1% fee (market linked), but pays 0.95% for servicing loans. If deal terms do not change, a buyback of a larger pool of loans implies incremental accrual of profit to the bank. The impact of the larger buyback by HDFC Bank seems to have normalised now and growth trends of AuM and on balance sheet loans are converging. Subsequently, the growth rate will now depend on the disbursal growth excluding buybacks which will trend the disbursal rate as of 24-30 months earlier.
Margins remain weak: NIM improved sequentially 3.9% (+10 bps q-o-q and -20bps y-o-y) – very seasonal for HDFC – near the lower end of the range seen in the last 20 quarters (3.65%-4.66%). Spread for the quarter was 3 bps lower on a y-o-y basis at 2.3%. Spreads in individual loans were flat y-o-y to 1.98%, and down 12 bps for non-individual loans at 3.02%.
Asset quality slightly worsened, credit cost returns to normal run rate: Non-individual loans GNPAs at 111bps were flat q-o-q and y-o-y. Individual loan NPAs (61 bps) worsened slightly. In Q4FY16, HDFC made a one-time special provision of R4.5 bn from R15.2 bn in capital gains from sale of shares in HDFC Standard Life to Standard Life (9% stake). This increased the credit cost from the 7-8 bps of interest earning assets seen in the 20 prior quarters to 80 bps. In Q1FY17, there was another capital gain of R9.22 billion from sale of 22.9% stake in HDFC Ergo General Insurance to the joint venture partner. R2.75 billion out of the above was used to make additional provisions in Q1FY17, driving the credit cost for the quarter up to 48 bps. In Q2FY17 the credit cost was 13 bps.
Profitability remains muted; well placed on capital: RoA was at 2.4% vs 2.5% y-o-y and q-o-q, while RoE was 20.1% vs 19.4% in Q2FY16. Core RoE was at 23.8% vs 24.2% y-o-y. Tier 1 level improved to 13.3% (vs 13.1% q-o-q) and CRAR was flat at 16.5% (vs 16.5% q-o-q).