All merger related negatives are in price; valuation re-rating is expected with improvement in FY25 ROA
HDFC Bank’s price performance (3Years: negative 1.72%, 1Year: negative 11.53%, 6months: negative 11.13%, and YTD: negative 15.6%) was lukewarm for previous three years. With merger overhangs, higher operating expenses (C/I: 40% of 3QFY24), reducing yields (owing to higher HL of HDFC Ltd) and marginally reducing ROA (~2% for 3QFY24); the bank has underperformed the whole sector. However, we believe, the negatives are in price as trailing P/BVPS (2.78x) is at comfortable level, whereas the 5-Year peak P/BVPS (5.8x) of the bank was on June – 19. The median P/BVPS for last 5 –Years was 3.8x. The trailing P/BVPS (2.8x) is way below the 5-Year median of 3.8x. We opine a turnaround from this point as the ROA is likely to stay stable despite higher operating expenses. We recommend a STRONG BUY with a TP of ₹1,762; a potential upside of 22% from current level.
Investment Rationales
Valuation comfort with best in class ROA: We expect the FY25E and FY26E ROA to stay at 1.9% with ROE to stay above 15%. The C/I ratio is likely to narrowed down to below 40% (38.8% for FY25E and 38.5% for FY26E). The bank’s NIM to improve to ~3.9% in FY25E/ FY26E (v/s 3.6% in 3QFY24) with the help of better loan mix (reducing portion of HL book) and lower COF (higher deposit growth with rapid branch expansion). We have incorporated YOA (calculated) of 9.2% in FY25E/FY26E against FY24 YOA (calculated) of 9.1%. The COF is expected to stay stable given high interest rate scenario. Credit growth to remain robust: We expect the loan growth of 20% and above (way above the sector growth). Mostly the growth is expected to come from high yielding unsecured credit. The current loan book composition has 30.4% share of HL (post-merger) which is likely to narrow down and PL share (7.4% in 3QFY24) is likely to improve. Additionally, the domestic corporate book (33.8% share) may improve further with strong underwriting process.
Asset Quality in fine fettle: The bank’s asset quality is best in the industry given strong underwriting practices. The current GNPA/NNPA/PCR at 1.26%/0.3%/75% with slippages contained below 2% annualised. We expect the NPA numbers to stay steady barring few seasonal hiccups from retail book.
Outlook and Recommendation
HDFC Bank is expected to overcome the merger overhangs gradually led by 1) healthy balance sheet growth, 2) much higher provision then regulatory requirement in the balance sheet, 3) best in class underwriting and risk management practices. Given these strengths we expect HDFC Bank to remain one of the best among all the lending businesses. Thus, we continue to maintain BUY rating (given historical lower valuation) on the bank with revised target price of ₹1,762
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