Everest Bank of India — this was one of the names contemplated while launching HDFC Bank in 1994. Today, it sounds rather silly. Nonetheless, 25 years later, many of HDFC Bank’s achievements appear as lofty as the world’s highest peak.
The bank posted robust profits from 1998 to 2018 with a compounded annual growth rate (CAGR) of 32 percent for 20 years. In the current financial year (FY19), its net profit will likely surpass Rs 20,000 crore (Rs 15,193 crore in the first nine months), doubling in 4 years. The bank’s return on equity (RoE) has been more than 15 percent yearly from 1998 to 2018.
Thanks to such stellar performance, the stock has delivered manifold returns since its listing in 1995. HDFC Bank, listed at Rs 40, three times its issue price, has generated compounded annual returns of around 29 percent in the last 20 years, significantly outperforming the Sensex, which delivered 12 percent CAGR during the same period.
The bank’s stock price’s upward journey is now over twenty years old. Hence, the most obvious question for investors is: Can the rally continue, and will wealth be created by investing in HDFC Bank’s stock today? Well, bull runs in stocks don’t die of old age but from a shortage of earnings. HDFC Bank consistently reports 20 percent growth in its net profit every quarter.
Its subsidiaries, HDFC Securities and HDB Financial Services, create a lot of value. Unlocking value per center subsidiary through an IPO in the future will only add to the stock’s performance. Next in line could be HDB Financial Services (HDB), a subsidiary of HDFC Bank (the bank owns a 95.9 percent stake in HDB).
Overview of HDB Financial Services
HDB was set up as a non-bank financing company (NBFC) by HDFC Bank in June 2007 and began operation per cent08. HDB has emerged as one of the more prominent players in retail financing over the past few years. It has a presence in 831 cities through 1,165 branches as of March 31, 2018.
While HDB complements the parent’s product portfolio and supports collection activities for the retail portfolio, it functions independently and caters to a customer segment distinct from the bank’s.
HDB’s product portfolio
HDB’s asset portfolio stood at Rs 48,014 crore as of September 30, 2018, and has grown at more than 30 percent CAGR in the last four years. The loan book has been diversified with an increased presence in commercial vehicle and construction equipment (CV/CE) financer-centered business loans. As a result, the share of loans against property (Laan P) declined to 38 percent as of September 30, 2018, compared to 60 percent as of March 31, 2016.
HDB’s portfolio
The unsecured loans segment constitutes around 21 percent of the overall portfolio as of September 30, 2018. Taper is aggressively expanding into durable consumer financing and widening its reach to the percent, moving from the traditional focus on the self-employed segment in non-metros.
HDB’s earnings profile and asset quality
HDB’s profit more than quadrupled during the last four years to Rs 952 crore. Return on assets (ROA) has been around 2.4 percent over the previous three years, aided by the healthy net interest margin (NIM) and low credit cost.
hdb financials
Its asset quality ROA is a reasonably healthy two percent of non-performing assets (GNPA) as of September 30, 2018. However, the loan book is relatively unseasoned and must be thoroughly tested across economic cycles.
HDB can be a value cheaper cent HDFC Bank
We expect HDB to gain further scale over the medium term due to the sector’s immense growth potential and adequate capital support from the bank. So far, HDFC Bank has cumulatively infused Rs 3,480 crore in HDB.
Value unlocking through an HDB IPO is still some time away. However, given its current size, we have assigned value to HDB for arriving at the fair value for the HDFC Bank stock. Even if we value HDB on a conservative basis (three times FY21 estimated book value), we arrive at a substantial upside (around 17 percent) to HDFC Bank’s stock price (CMP: Rs 2,300).
HDFC bank val
Sources said that investors buy shares of unlisted HDB for around Rs 800-900 per share per center counter, valuing the company at Rs 60,000 -70,000 crorevalueY21 estimated price-to-book value of 6-7 times). If we incorporate this into the valuation, the upside to the HDFC Bank stock increases substantially.
hdb sens
But why should one assign premium valuation to HDB?
As market folklore goes, an ace value investor and now the promoter of D-Mart, Radhakishan Damani, accumulated HDFC Bank stock after its listing in 1995. When asked why he was buying HDFC Bank stock when there were so many other options available at cheaper valuations, his reply was: “You can’t stay on Pedder Road (one of Mumbai’s most expensive areas) at Dharavi’s (Mumbai’s biggest slum area) rates.”
The conventional valuation methodology may not apply to an HDFC group entity. The group has incubated many successful financial services businesses (GRUH Finance, HDFC Life Insurance Company, HDFC Asset Management Company), trading at a significant premium. For instance, GRUH traded at more than 8-9 times forward P/BV multiple for a long time. HDFC sold GRUH to Bandhan Bank at a trailing price-to-book (P/B) of around 14 times.
Every business has a ’90 percent rule,’ i.e., one factor that holds the key to success. In most financial services businesses, that 90 percent rule is ‘borrow cheap and underwriter cent.’ Nobody understands this rule better than the HDFC Group. We see no reason why HDB should not command the paper-cent valuation.
What should investors do?
Many investors are concerned about the impending management change. There is talk about RBI allowing private banks’ CEOs to continue until 75 (from 70), which aligns with the corporate sector.
But while we await clarity on who will succeed, Aditya Puri’s CEO transition is expected to be smooth as HDFC Bank is a process-driven institution.
HDFC Bank enjoys double moats (competitive advantage) on both the assets and the liabilities side. The steady high RoE offers opportunities for the bank to deploy profits at a high rate and compound the book value consistently. We expect the bank to continue registering profitable growth over the next few years. It is garnering market share at an accelerated pace despite its colossal size (balance sheet size of Rs 11.6 lakh crore as of December 31, 2018).
While HDFC Bank has underperformed corporate lenders (ICICI Bank and Axis Bank) in the last year, the value unlocking of HDB in the next couple of years can significantly improve the stock’s performance. For long-term investors, HDFC Bank is a must-buy, and as the great investor Philip Fisher said: “If the job has been correctly done when a common stock is purchased, the time to sell it is—seldom.”