Event update: HDFC Bank (Outperformer) - The best is yet to come

HDFC Bank hosted an analyst meet where we interacted with the CEO, the heads of key verticals and the MD of HDB Financial Services. The key takeaway was that the best is yet to come. HDFC Bank is in a sweet spot given the deteriorating financials of state owned banks, their focus on bad loan resolution and consolidation rather than loan growth, and continued corporate stress for key corporate private banks. Given its strong distribution reach in rural and urban areas, a strong and scaleable digital platform, low cost of funds and quick turnaround time for loans, HDFC Bank is in a strong position to grab market share in retail and corporate loans. Already, HDFC Bank’s incremental market share in retail loans has touched 25% against an oustanding share of 9% and its total incremental loan market share has touched 31% against an outstanding market share of  8% of total loans as of June 2017. We have computed market shares from  RBI’s data on sectoral deployment of credit. The bank has a cushion of 1.5% on pre-tax RoA across retail products because their actual losses are lower than their expected losses. This cushion can be used to support earnings if competition intensifies. While the CEO mentioned that the bank is willing to take 30 bps lower margins for higher market share, we expect margins to remain stable even as market share accelerates given the recent cut in savings rate. Mr Aditya Puri will retire in 2020 and it has been decided by the board that his successor will be in place a year before his exit.

We are increasing our earnings for FY19E and building in earnings for FY20E. We note that loan and earnings growth can accelerate in 4Q18 given the low base effect from liquidation of FCNR B deposits in 4Q17. We expect HDFC Bank’s profit growth to improve to 26% in FY19E from 21% in FY18E and 18% in FY17. We expect profit growth for FY20 remain strong at 24%. There is an impression that HDFC Bank will maintain reported earnings growth at 20-22% even if core growth is higher given that they are conservative. However, from today’s meet we got a sense that the bank can show higher earnings growth (of more than 22%)  if the current momentum continues.

We are revising our target multiple on the stock to 4.5xPBV from 4x earlier to factor in higher market share gains and cost efficiencies from digitisation. We believe HDFC Bank’s premium to the sector should widen given its strong financials, sound risk management practices and market share gains amidst deteriorating financials of state owned banks and continued stress at other corporate private banks. Our standalone target price works out to Rs2,085. We attribute Rs66 per share to HDFC Bank’s subsidiary HDB Financials valuing it at 3.5x existing book value. This subsidiary has shareholders’ funds of Rs536bn, loans of Rs316bn and an RoA of 2.5% for FY17. Our consolidated target price works out to Rs2,150 against Rs1,855 earlier.  HDBK remains our top pick.