HDFC Bank - Notable earnings: Buy

Strong loan growth, steady margins and stable asset quality are positives

The ongoing turmoil in the non-banking finance space and no significant recovery in the earnings of public sector banks have turned investors’ focus back to select private sector banks that have managed to grow earnings steadily over the past year, despite headwinds in the sector.

HDFC Bank’s strong loan growth, steady margins, improving cost-to-income ratio and stable asset quality, led to earnings growth of 20.5 per cent Y-o-Y in FY19.

At the current price, the stock trades at about 3.8 times its one-year forward book value. This is within its long-term (five-year) range of 3.4-4 times, despite the 20 per cent rally in the stock over the past year.

Steady earnings growth of 18-20 per cent over the past four quarters has kept the stock’s valuation at a reasonable level.

Long-term investors can buy the stock at current levels.

 

Resilient performance

Over the past few years, even as its peers have been dogged by asset quality issues, HDFC Bank has managed to keep its earnings in good stead. Between FY16 and FY19, the bank’s loans have grown by about 21 per cent CAGR (compounded annual growth rate). Net interest margins have been steady at 4.3 per cent levels, while the bank’s cost-to-income ratio has fallen substantially to 39.9 per cent in FY19 (from 44.3 per cent in FY16).

With asset quality more or less stable (rise in bad loans in absolute terms offset by strong growth in loans), net profit has grown by a healthy 20 per cent CAGR between FY16 and FY19.

Corporate loans buck the trend

After delivering sub-20 per cent loan growth in the previous two fiscals, HDFC Bank managed a higher 24 per cent loan growth in the FY19 fiscal. The growth was backed by strong uptick in corporate loan growth, even as there was a considerable slowdown in retail loan growth, owing to the underlying weakness in the four-/two-wheeler segments.

After reporting a robust 27 per cent growth in FY16, overall loan growth moderated to 18-19 per cent levels in FY17 and FY18. Slowdown in corporate loans had affected growth in FY17. In particular, in the December 2016 quarter, corporate loan growth was impacted by the unwinding of the leveraged product the bank offered under the FCNR deposit scheme and repayment of some of the working capital loans by SMEs, post-demonetisation. In FY18, corporate loans grew by a more modest 9 per cent. In FY19, there has been a significant pick up in corporate loan growth (at 31 per cent).

On the other hand, retail loans — that have been a key driver of growth for HDFC Bank in the past few fiscals — grew by a lower 19 per cent in FY19 (from 26-27 per cent growth levels in FY17 and FY18). Significant slowdown in growth across most segments — in particular, auto, two-wheeler, business banking and Kisan Gold Cards — impacted retail loan growth in FY19. As a result, retail loans constituted 54 per cent of the overall loan portfolio as of March 2019 (from 57 per cent in FY18).

While the spurt in corporate loans may moderate, and the underlying weak trends in the retail space may persist in the near term, a diversified loan book should keep growth in good stead over the long run. Good traction in lending to high-rated corporates and BS-VI pre-buying driving CV financing in the later part of the fiscal, should also augur well for growth.

 

As of March 2019, the bank’s deposits stood at ₹923,141 crore, a healthy growth of 17 per cent Y-o-Y. While the savings deposits grew by a lower 11 per cent, the bank indicated that this was due to migration of customers to fixed deposits, where the rates are higher. Overall, the bank had a healthy low-cost CASA (current account savings account) deposit ratio of 42.4 per cent, which should continue to aid margins.

Bad loans up marginally

Since FY17, gross non-performing assets (GNPAs) for the bank, in absolute terms, have been growing 30-40 per cent Y-o-Y. However, strong growth in loans has kept delinquency ratio (GNPA as a per cent of loans) under check. But the bank has been facing stress in its agri portfolio, which may need a watch. That said, a higher provision coverage ratio of 71 per cent (floating provisions of ₹1,451 crore) mitigates risk. HDFC Bank’s GNPAs, that was hovering around the 1 per cent mark in the past, inched up slightly over the past one year — in the latest March quarter, the bank’s GNPA stood at 1.36 per cent of loans.

The bank is well-capitalised to fund growth over the medium term. Its total capital adequacy ratio stood at 17.1 per cent as of March 2019, against a regulatory requirement of 11.025 per cent (including capital conservation buffer and an additional requirement of 0.15 per cent on account of it being identified as a Domestic Systemically Important Bank). Tier 1 capital adequacy was 15.8 per cent.

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