Brokerage firm Emkay Global has a 'buy' call on HDFC Bank with a target price of ₹1,800 which is a 38 percent upside from the stock's May 23 closing of ₹1302.90.
Even though the brokerage firm has maintained the buy call on the stock due to comfortable valuations, it has cut the target price to ₹1,800 from ₹1,950 and said that the regulatory drag will hurt the near-term return on equity (RoE).
Emkay Global pointed out that HDFC management has been vocal that the regulator has clearly indicated that large NBFCs/HFCs need to either operate with bank-like rules or convert into a bank, while housing business at a scale is best done now under a bank given their cost advantage and potential cross-selling benefits.
That said, HDFC shareholders’ may be apprehensive about selling housing/other businesses at valuations inclusive of holdco discount. For HDFC Bank, the merger of the housing portfolio could be RoE dilutive in the near term due to regulatory costs, but brings scale, security and higher portfolio tenure with better long-term RoEs, factoring in cross-selling/leverage benefits, the brokerage firm said.
Emkay believes the Reserve Bank of India (RBI) may have reservations in approving the proposed merger deal structure with non-lending businesses (mainly insurance with current stakes of more than 30 percent) under the bank, as it will challenge its longstanding stance to ring-fence banks and avoid regulatory overlap.
"Allowing NBFCs HDB Fin/HDFC Credila as subsidiaries under a bank could also be difficult given the RBI’s insistence to undertake lending business primarily under the bank," Emkay underscored.
Emkay said HDFC Bank has allayed concerns on growth on the large balance sheet post-merger, as it believes that the bank and HDFC - on a combined basis - have grown at a healthy pace (nearly 18-20 percent) in the past (pre-Covid) and could see continued momentum with better opportunities to grow the housing portfolio as then most branches will be able to offer housing loans based on the bank’s template.
The bank would also not shy away from continuing developer loans if it fits its risk-return profile. The bank believes
that 18-20 percent credit growth after the merger in a BAU scenario looks sustainable, subject to macro support. It claims that globally larger banks have also grown at a healthy pace, and thus size should not be a constraint for growth, particularly in India amid gross credit under-penetration, said Emkay.
"Based on the Gordon growth model for the merged entity and factoring in a slightly higher CoE, we work out fair value at 2.7 times FY24E ABV for the merged bank (10 percent discount to FV basis merger overhang) or implied 3 times ABV of the standalone bank (pre-merger) against earlier 3.2 times ABV of the standalone bank," said Emkay.
"Add to that the subsidiaries’ valuation of ₹172 per share for the merged bank ( ₹78 for standalone bank pre-merger), we arrive at a target price of ₹1,800. The stock has seen a sharp correction due to sub-par core profitability performance, which in turn was driven by lower margins/fees and merger overhang, thereby trading at near-trough valuations (trading at 2.1 times FY24 standalone ABV/1.9 times merged ABV)," Emkay added.
Disclaimer: The views and recommendations made above are those of the broking firm and not of MintGenie.
