Sunday, March 16, 2014

HDFC Bank - Excellent Bank but too rich for now

BSE: 500180|NSE: HDFCBANK|ISIN: INE040A01026

Highest quality bank in the country. Has growth net income by 30%+ year on year for over 4 years. Lowest gross NPAs in the country among the big banks at 0.97%. Dec 2013 quarter NPAs are slightly higher at 1.1% which still keeps it among the top banks. Very few things would keep me up at night about this as a company.



1. How good is the moat?

Grade A moat
  • Customer stickyness: The brand is strong but customers are unlikely to shy away from shifting to another big name bank.
  • Sales pipeline: Very strong but nothing special relative to the competition. In fact I would say HDFC is less aggressive than for example Kotak.
  • Scale: This is one of the big banks with a good brand along with SBI, ICICI, Kotak and others. The Bank has over 3000 branches in over 1800 cities with more than 28.7 mil customers which is over 2% of the Indian population. Is in the top 3 by net income, top 4 by revenues, top 2 by net profit margins.
  • Lending safety: This is where HDFC Bank scores its grade A moat. Their discipline in getting what they want as security and loan safety is the highest. I have never heard of anyone saying HDFC dropped some loan requirement to close a deal - whereas people will always say that about some bank or the other.
  • Growth: India's domestic credit to private sector as a % of GDP in 2012 is abysmal at 51% as per world bank data. Most of the developed world is over 100%. Which means that the credit market has lots of growth left. The question for banks is how to tap on this growth without loosing your shirt. I think HDFC Bank is poised to take the maximum advantage of this situation.

2. Risks

  • Macro-economic risk: Runaway inflation could hurt the entire banking industry.
  • Banking to small transaction size consumers could raise costs
  • 57K Crores of unsecured advances - around 1/4th of the advances are listed in this section. Not many details are provided and this worries me.

3. Financials

  • Capital adequacy ratio is over 16% & Tier 1 capital is over 11%.
  • Net interest margin of 4.5%
  • Commission and brokerage as a % of revenues has fallen by 1% or so over the last 5 years
  • Deposit % of total borrowings is 88%+ which is very high - and very healthy.
  • 2 Subsidiaries - both seem to be profitable. Size is very small and probably dont play a major role currently for this business
  • No insurance exposure

4. Soft factors

  • The growth of the company has been stellar. EPS has grown faster than the ROE itself - showing that there was excess capacity that was used to deliver the EPS. Further room for growth is massive as credit is still scarce in India.
  • Shareholding: 
    • Company was originally floated by HDFC which in turn was floated by ICICI.
    • In this case the promoter so as to say is not a family or a set of individuals but an organization
    • Overall ADS depository JP Morgan owns 16 % which I presume is equity swap holdings overseas. Further FII holdings are 34% - over 50% holding is FII. Capital flows to india will be driving this stock.
  • Employee relations - are good. The HDFC jobs are coveted but not as much as the foreign banks yet.
  • Index % is 4.8% or so.

5. Pricing

  • This is highly tricky as its the first company I have seen that has been able to consistently grow earnings faster than the ROE %.
    • Is there room to grow? A resounding YES!
    • Can it keep the efficiency up at these levels? Probably.
    • Growth has slowed down in FY2014
  • We can safely expect this bank to grow earnings 20% for the next 5 years and maybe 10% per year for a few years after that.
  • The current price of 21.3 times Dec 2013 numbers is a bit too rich - might be a value investment anywhere around 14 to 15 times earnings. At current prices the investors still might make good returns as this is the darling of the markets but is not a value investment at this price.