The Housing Development Finance Corporation’s (HDFC’s) merger with HDFC Bank became effective on July 1 and the former will stop trading on the bourses from July 13.
Now that the merger is complete, global brokerage house Morgan Stanley believes that HDFC Bank is a compounder available at attractive valuations. The brokerage has resumed its coverage with an ‘overweight’ stance and a target price of ₹2,110, indicating a potential upside of 24 percent.
“HDFC Bank trades at 16x one-year forward EPS, 20 percent below the 15-year mean. Strong trailing investments and cyclical tailwinds (benign asset quality and improving real deposit rates) will help it navigate merger challenges better and return to 17-18 percent EPS growth after Year 1,” it said.
HDFC Bank has a strong track record of delivering investor returns. Additionally, MS expects the bank to benefit from cyclical tailwinds, which will assist in navigating the challenges posed by the merger.
Stock price trend
Shares of HDFC Bank have underperformed the benchmarks in the last 1 year. The stock has gained around 26 percent in this period versus a 34 percent rise in the Nifty Bank. In the last 3 years as well, Nifty Bank has given multibagger returns, rising over 106 percent while HDFC Bank has advanced only 60 percent.
Meanwhile, in 2023 YTD, HDFC Bank was up nearly 6 percent as against a 5 percent gain in Nifty Bank. The private sector lender has given positive returns in 3 of the 6 months completed in the current calendar year. It rose 5.6 percent in June after a 4.5 percent decline in May. However, it added 4.8 percent and 0.6 percent in April and March, respectively. The stock shed 0.24 percent and 1.5 percent in Feb and Jan, respectively.
Investment Rationale
Powerful merger: As per the brokerage, the merger is synergistic. HDFC Bank gets access to secured and long-tenor retail mortgage products as well as a large customer base. Its product suite – plus direct access to insurance and other subs – and geographical reach are superior to those of most private banks, added MS.
Consistent growth: MS also stated that over the past decade, it has invested in semi-urban and rural India, gaining a strong market share. In recent years, the bank has improved digital capabilities and is focused on building ecosystems that can accelerate cross-selling ratios and drive operating leverage, it noted.
“HDFC Bank has historically invested well ahead of time, thereby sustaining strong loan growth even as the macrocycle turned challenging; for instance, it has significantly accelerated investments in semi-urban rural India, which has helped sustain strong loan growth over the past three years even as retail slowed. The commercial and rural banking (CRB) book has doubled over the past three years and in the MSME segment, market share increased by more than 50 percent over the past two years to 18.5 percent,” it said.
Strong track record: HDFC Bank's track record on deposit market share gains is unmatched in India across current account deposits (CA), savings account deposits (SA), and retail term deposits, said the brokerage. Even in F23, HDFC Bank registered strong retail deposit growth of 23 percent YoY in F23even as the system likely grew 10 percent YoY. To an extent, this is also helped by its early entry into high-potential customer segments as well as new geographies. MS continues to expect sustained strong growth, helped by strong distribution expansion and increased engagement levels; higher cross-selling ratios, particularly to mortgage customers; and increased digital acquisitions. It believes the bank has significant scope to increase cross-selling of retail term deposits within its existing customer base.
Strong outlook: The brokerage said that it remains constructive on India's macro outlook and expects asset quality to remain strong. It expects loan growth has held up well, and system deposit growth should accelerate as real deposit rates have improved. Credit costs will remain low and help HDFC bank up-front its distribution expansion, predicted the brokerage.
Estimates
The brokerage sees F24e EPS growth at 13 percent YoY will be lower, partly owing to certain one-time merger-related adjustments. It expects the merged loan growth to accelerate from 15-16 percent currently to 17-18 percent in four quarters, particularly as mortgage loan growth accelerates.
Following initial moderation of 20-30 bps, it also expects margins to remain in a tight range, due to a) loan mix shift away from corporate lending, b) gradual shift of higher-cost borrowings into retail deposits, c) lagged repricing of the fixed rate loan book.
It further noted that HDFC Bank has already accelerated the pace of branch expansion, which is also aided in part by low credit costs. MS believes this can continue over the next few years, which would be helpful to sustain.
MS also estimates a re-rating over the next year as a) post-merger profitability (RoA) remains in the 1.9-2.0 percent range; and b) loan growth accelerates to 18 percent over the next year, compared to current pro forma merged loan growth of 15-16 percent.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.
