The past year has seen HDFC Bank (HDFCB) underperforming its peers by 42%, weighed down by several concerns?both technical and fundamental. We expect HDFCB to outperform once the technical hurdles are behind it as we believe the fundamentals underpinning it are still intact. We analyse investor concerns around slowing retail advances growth/fee income and higher asset quality stress and come to the conclusion that the underlying drivers for growth/asset quality remain intact. Our analysis suggest the underlying retail advances growth continues to remain strong after accounting for the reclassification of business banking and consolidation of its HDB Financial subsidiary. On the fee income front, we believe the impact of regulations is already in the base numbers and expect growth to improve in FY16e as underlying drivers remain intact. In addition asset quality excluding CV/CE (commercial vehicle/construction equipment) still remains strong. Reiterate our Buy, with an unchanged FV (fair value) of Rs 975.
HDFC Bank underperformed due to several technical and fundamental factors-Technical factors include the reduction in weight in the MSCI (Morgan Stanley Composite Index) and now removal from MSCI, while fundamental factors weighing on the stock are (i) lower retail advances growth; (ii) lower fee income growth, (iii) higher asset quality stress and (iv) uncertainty around merger and management transition.
Fundamentals intact
With clear management visibility post the RBI notification increasing the retirement age of bank CEOs, the focus shifts to fundamentals, which are still intact for HDFCB even in this difficult environment:
Underlying retail advances growth still strong: Despite the slowdown in the overall retail credit growth, the underlying drivers of the segment continue to show strong trends. We specifically look at the performance of the business banking segment (.24% of retail advances) and see that the underlying growth continues to remain high at 30% year-on-year growth. In addition, accounting for the growth in its subsidiary HDB Financial, growth is nearly 300bps higher.
Core fee income growth to pick up: While several regulatory changes have reined in fee income growth, the drivers for fee income remain intact and continue to post robust growth numbers ? (i) customer growth (11% CAGR) ; (ii) debit card transaction growth (23% CAGR) & (iii) credit card transaction growth (42% CAGR). While forex fees continue to post strong growth driven by retail clients (66% of FX fees contributed by retail) third party distribution is expected to start growing from a low base as HDFC Standard Life (50% of third party fees) starts to gain market share.
Asset quality excluding CV/CE still remains strong: We believe the headline gross slippages of 1.65% of advances is not a true reflection of the underlying asset quality of HDFCB due to (i) grossing of intra quarter slippages, (ii) more churn in small ticket size advances & (iii) lower restructuring. Also, we show that except CV/CE the asset quality of other segments remains stable.
HDB Financial
Another growth engine ignored by the market: HDB Financial is a NBFC subsidiary of HDFC Bank and is primarily into auto, commercial & residential real estate; shares and gold loans related lending activities. The subsidiary has grown at a fast rate during the last four years at a CAGR of 124% to an AuM (asset under management) size of nearly R134 bn. LAP?loan against property?(57%) and auto finance (30%) form majority of the advances portfolio. During this period RoE (return on equity) of the subsidiary increased steadily from a low of 3.8% during FY09 to 16.7% as of FY14.
Meaningful in size, contributing to consolidated PAT: Including the advances of HDB Financial which are primarily retail in nature, the consolidated retail advances growth for HDFCB is nearly 300 bps higher than the standalone bank. Given that the NBFC has now increased substantially in size and together with improved RoEs, the contribution to the consolidated profit after tax will increase from a meagre 2% as of FY12 to nearly 5% as of FY16e.
To conclude, while the headline number for HDFC Bank shows a slowdown in the retail advances growth after accounting for reclassification and consolidation of subsidiary HDB Financial, the underlying growth of retail advances is significantly higher.
Reiterate Buy: The last remaining technical hangover for HDFCB is the possibility of exclusion from the MSCI EM (emerging market) index during the Nov 2014 Semi-Annual Index Review by MSCI if the status quo on FIPB (Foreign Investment Promotion Board?s) decision not to raise FII limit continues. We believe this provides a good buying opportunity as we expect HDFCB to outperform post this event given its fundamentals remain strong. Reiterate our Buy stance, with an unchanged fair value of R975. Based on the historical valuation we can see that HDFC Bank is trading close to its historical average of 3.3x. On a P/E (price-to-earnings) basis the bank is currently trading at a one-year forward P/E of 18x, which is 1 standard deviation below its historical multiple of 21x. With steady state RoE (return on equity) of nearly 20% and short-term earnings growth of more than c.26% we believe the fair multiple for HDFC Bank is 3.5x (based on our Two State Gordon Growth model).
By Espirito Santo