The banking sector has a very close relationship with the economy in terms of the sectors' growth. A robust economy would imply robust credit growth and the banking sector stands to be a direct beneficiary. With a government change likely in India in May 2014, the party slated to come to power promises significant economic reforms. The Indian equity markets are already discounting the positive with the market at record high levels. Individual stocks, however, still hold immense potential, and this article discusses why HDFC Bank (HDB) can be a catalyst for the portfolio.
About HDFC Bank
HDFC Bank (HDB) is the second largest private sector bank in India and can potentially become the largest private sector bank by overtaking ICICI Bank (IBN) relatively soon. As of Sept. 30, 2013, the company operated a network of 3,251 branches and 11,177 ATMs in 2,022 cities/towns. For the year ended March 2013, HDFC Bank had a total asset size of $71 billion with one of the best asset qualities (net NPA of 0.2%). Further, the bank had a net interest margin of 4.47% for the same period.
On Indian Financial Services Penetration
Before discussing the positives related to HDFC Bank, I would like to provide some numbers related to the penetration of the financial services industry in India. These numbers will underscore the point that there is immense scope of growth for the Indian banking sector and HDFC Bank is well positioned to capitalize on the growth (being the second largest player in the Indian banking industry).
According to the Reserve Bank of India, 57% of the population has a savings bank account, 10% and 0.6% of the population have life and non-life insurance, respectively. Further, only 13% of the population holds a debit card, and 2% have credit cards. To top all these statistics, the consumer debt to GDP for India is just 8.5%.
With an improving economy, rising income levels, rising standards of living and increasing awareness of financial products, the upside growth potential for the banking sector is huge.
On Interest Rates In India
Another factor, which is important to discuss before discussing the fundamentals of HDFC Bank, is the prevailing interest rates in India. This is important to discuss because higher interest rates have resulted in relatively depressed banking sector stock performance.
However, I do believe that the interest rates have peaked out in India with the repo rate at 8% and reverse repo rate at 7%. With the government likely to change in May 2014, new economic reforms should help curb inflation. Investors can therefore expect that interest rates trend down from current levels on the foreseeable future. This will be positive for the banking stocks.
HDFC Bank’s Growth Strategy
HDFC Bank had an aggressive growth strategy in the last few years (revenue CAGR of 32% from 2003 to 2013) and that has been associated with high asset quality (NPA of 0.2%) and a superior net interest margin. I believe that the company’s growth will sustain in the medium to long-term judging by the growth strategy the company follows.
HDFC Bank’s primary emphasis is on retail banking, and the bank has made significant inroads in the Indian rural sector. This gives HDFC Bank an edge over its peers and gives the bank the necessary growth momentum with huge under-penetration in the Indian rural banking sector.
To back my point with numbers, the company's rural and semi-urban branches have increased to 53% of the total number of branches in March 2013 compared to 34% in March 2010. Given the penetration numbers discussed above, the potential for growth is still immense and HDFC should continue to grow at a robust pace.
High CASA Ratio Supports Growth
Another key differentiating factor for HDFC Bank as compared to its closest peer, ICICI Bank is the net interest margin the bank generates. HDFC Bank has a net interest margin of 4.6% as compared to 3.2% for ICICI Bank. The higher net interest margin is due to a higher CASA ratio.
HDFC Bank had a CASA ratio of 47.4% for the year ended March 2013 compared to 41.9% for ICICI Bank. The CASA ratio indicates a higher portion of bank deposits coming from current and savings account, which means that the bank is getting money at a lower cost. As HDFC Bank continues to penetrate in the semi-urban and rural areas, the CASA ratio will remain strong and give the bank an edge over its peers.
HDFC Bank is among the strongest private sector banks in India. The bank has shown immense strength in the credit crisis and the bank's low NPA makes it a safe deposit haven for the retail population.
The bank's key metrics are strong and HDFC is well placed financially to grow at a robust pace as the Indian economy recovers. Political change and lower inflation will add to the growth momentum for HDFC Bank. Investors can consider exposure to the Indian banking giant with a one- to two-year time horizon for robust returns.