1. Buy rating on HDFC Bank: On course to outdo peers

Buy rating on HDFC Bank: On course to outdo peers

HDFC Bank (HDFCB) continues to grow well in excess of the system (headline and retail) taking in market share while managing credit costs.

By: | Updated: February 1, 2016 2:17 AM

HDFC Bank (HDFCB) continues to grow well in excess of the system (headline and retail) taking in market share while managing credit costs. That remains the core thesis of our Buy argument on HDFCB within retail banks. We have toned down expectations marginally—growth and NIM— and lowered PT (price target) to R1,300.

Strong growth in Retail assets, Wholesale remains supportive: Loans and advances grew at a fairly strong 25.7%, but came in 5% below our estimate. As per the bank’s internal classification, proportion of retail (including business banking) is 63% of loans, growing at 29%, while wholesale was up 20% y-o-y (year to year), coming off from 26% y-o-y seen in Q2FY16.

Falling credit costs, asset quality under control: Gross NPA (0.97%) was largely flat on a y-o-y basis (0.99% as of Q3FY15), but marginally deteriorated on a sequential basis (0.91% as of Q2FY16). Restructured assets continue to remain 10bps of the loans. Slippage ratio has normalised to sub-2% levels. Provision coverage deteriorated to 70.4% from 72.9% as of Q2FY16 due to higher share of substandard assets in the NPA loan mix.

hdfc

NII grew 24% y-o-y, driven by strong growth in advances and sequentially higher NIMs (4.29% vs. 4.2%). CASA (current account savings account) ratio was 40.9% vs. 39.7% in Q2, but was flat at 39.5% adjusting for a one-off in CA.

Non-interest income grew at a relatively muted 13.3% y-o-y (5.3% below JEFe), driven by slowdown in third party distribution fee, and discounts during the festive season, but was buoyed by trading profit (+23.5% y-o-y). Expense ratio trended lower to 42.3%. Core PPOP (pre-provisioning operating profit ex trading profits) and net profit were up 20% y-o-y— in line with consensus, but close to 3% below JEFe. Profitability was strong–RoA (return on assets) 2%, RoE (return on equity) 19.7% improving sequentially. CET1/ Tier1 ratio improved to 13.2%, CRAR (capital to risk weighted assets ratio) to 15.9%, driven by lower growth in risk-weighted assets.

We have toned down loan growth estimates and lowered NIM forecasts to reflect pressures from MCLR (marginal cost of funds based lending rate) implementation and a competitive environment. This results in a ~4% fall in EPS (earnings per share) in FY16 and FY17, and ~6% in FY18. We forecast EPS CAGR of 22.5% over FY15-18.

We value HDFCB at 3.6x book (Dec-16) and 17x EPS (12m to Dec-17). It trades at 3.86x book (Dec-15) and 17.7x EPS (12m to Dec-16)–10 year average of 4.34x and 20x respectively.

Key risks: weak loan growth and asset quality

Loans and advances grew at a fairly strong 25.7%, but came in 5% below our estimate. Retail loan growth came in mainly from housing loans (+42% y-o-y), personal loans (+42% y-o-y), credit cards (+28% y-o-y) and business banking (+22% y-o-y). Auto and

2-wheeler loans were up 23% and 29%, while CV/CE (commercial vehicle and construction equipment) portfolio grew 19% vs. 18% in sequential quarter.

Home loan has been exceptionally strong in the last three quarters. Management indicated they are retaining a higher proportion of loans on their books. This is driven by HDFC Bank buying back a higher proportion of the housing loans it originates (70% as opposed to 50% earlier) from HDFC. Management indicated that the effect of this will be seen in the form of a higher base throughout this year, and growth rates should normalise by September 2016 to reflect that of origination (seen in FY14).

Gross NPA (0.97%) was largely flat on a y-o-y basis (0.99% as of Q3FY15), but marginally deteriorated on a sequential basis (0.91% as of Q2FY16). Net NPA ratio followed a similar trend, coming in at 0.29%.

Management stated that the Reserve Bank of India’s annual review had no impact on bad asset recognition and negligible impact on credit costs. The bank does not have any accounts under 5-25 refinancing or strategic debt restructuring as of now. Provision coverage deteriorated to 70.4% from 73.9% a year ago and 72.9% as of Q2FY16, largely driven by higher share of substandard assets in the NPA loan mix, for which the bank typically makes lower provisions as compared to that made for the remaining NPA book. The floating provision remained unchanged at R16.4 bn, implying 38bps of loans versus peak level of 79bps in Q1FY13.

NII (net interest income) grew 24% y-o-y, but was 4% below our estimates, driven by lower than expected growth in advances (~+26% y-o-y, 5% below JEFe) and weaker than estimated NIM (4.29%), although this improved on a sequential basis by 10bps. Management indicated that capital raising in Q4FY15 would have contributed only 5-6bps to the total margin. Even after adjusting for this, the same continues to remain in the 4% to 4.3% target range. Even as Savings grew at 20.6% y-o-y, and the current account grew ~30%, CASA ratio only marginally improved to 40.9% from 39.7% in Q2FY16, as term-deposits (of which ~70+% is retail) continued to show strong growth, up +34.5% y-o-y. Core CASA grew by 23% y-o-y, with the balance growth accounted for by a one-off. Adjusting for this, the CASA as of Q3FY16 would be ~39.5%.

Non-interest income grew at a relatively muted 13.3% y-o-y (5.3% below JEFe), driven by 11% growth in core fee income (third party distribution, liability commissions), which came in at 10% below our estimate, but was buoyed by trading profit (+23.5% y-o-y). Weakness in fee income growth can be attributed to third party fees in mutual funds and insurance business coming off, and to waivers/discounts offered to retail customers during the festive season.

Operating expense growth (+21.7% y-o-y) was slightly higher than that of the total revenue (+20.7% y-o-y). Expense ratio was 42.3%. Core PPOP (pre-provisioning operating profit ex trading profits) was up ~20% y-o-y (2.4% below JEFe).

Management guided that apart from robust business growth, the strong growth in employee addition was due to a catch-up in employee level post stagnation seen in FY13-14. This is not expected to play out further, and the future increase in work force will be in line with business growth. Management also indicated that branch expansion will continue at a moderate pace, as opposed to that seen in Q4FY15 (355 new branches, as opposed to 267 in 9MFY16).

Net profit was up 20.1% y-o-y (~3% below JEFe). Profitability ratios were strong – RoA at 2%, RoE at 19.7%, and improving sequentially. The bank continues to remain well capitalised, with Common Equity Tier 1 (CET1)/Tier1 ratio at 13.18% and CRAR at 15.91%. The improved capital ratios were due to expiry of certain securitisation contracts, which led to release of certain credit enhancement limits, a one-off, and lower regulatory requirement for small housing loans. Management indicated that the annual capital consumption should be in the range of 50-75 bps based on current regulations.

We have toned down our loan growth estimates by ~2%, ~4% and ~6% for FY16, FY17 and FY18, respectively. We have lowered NIM forecasts by 5bps in FY16 and 1bp each in FY17 and FY18 to reflect pressures from MCLR implementation and a competitive environment. This results in a ~4% fall in EPS in FY16 and FY17, and ~6% in FY18. We forecast EPS CAGR of 22.5% over FY15-18

—Jefferies

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