In an ideal scenario, a long-term portfolio would have a combination of stocks from different industries. There are some sectors of the economy that are bound to do well when the economy does well. Further, there are some sectors of the economy that need to remain robust in order for the economy to do well. The banking sector is one such sector that invariably does well with growth in economic activity. Additionally, the banking sector of any country has to be healthy for the economy to gain traction.
The banking stock being discussed is not from the United States, China or Japan. Rather, the country where this bank operates has approximately 47% basic savings account penetration.
HDFC Bank Ltd. (HDB, Financial) is India’s second-largest private sector bank after ICICI Bank (IBN, Financial). While both banks are attractive for the long term, I like HDFC Bank on a relative basis.
From a stock returns perspective, HDFC Bank is already higher by 20% for 2017, but there is significant juice in the rally for the long term and I suggest fresh exposure even at current levels.
The demonetization impact
The entire exercise of demonetization of higher value notes by the Indian government was focused toward flushing out black money. Another key objective the government is working toward is a cashless economy.
This is where the banking sector stands to benefit. India’s economic survey report suggests basic savings account penetration is just 47%. In my view, this penetration is likely to swell in the coming years, which will help HDFC Bank beef up its balance sheet as well as increase the volume of business.
The key point is banking penetration in India is lackluster in the rural areas. HDFC Bank has been making inroads in this high growth potential area. As of fiscal 2013, the company had 16% of its branches in rural areas. In 2016, its number of rural branches increased to 23%.
The demonetization impact also implies savings and current account deposits have swelled and will continue to increase in the coming quarters. This is significant as HDFC Bank has one of the best CASA ratios in the Indian banking industry. I expect the CASA ratio to be in the range of 45% to 50%. As a result, the bank has a robust net interest margin of 4.31% for fiscal 2016. Since deposit costs will likely remain low, the NII margin will remain healthy.
Increasing non-funded revenue
For HDFC Bank, non-funded revenue has been trending higher and other income (non-fund revenue) was 28% of net revenue in 2016. The major components of non-fund revenue include fees and commissions, foreign exchange derivatives and recoveries, among others.
I wanted to stress this component of revenue because Indian banks have started cash withdrawal charges after a certain number of transactions. In an effort to push toward digital payments, banking charges may increase as a component of net revenue.
Retail loans growth
Growth in retail loans is another segment that is likely to deliver long-term returns. HDFC Bank has a well diversified and growing mix of retail loans, including auto loans, personal loans, home loans, credit card and gold loans, among others.
The key point to note here is interest rates have declined from peak levels in India, which can potentially spur credit growth if broad economic metrics also remain healthy. While demonetization has impacted growth to some extent in the near term, I am of the view India is on a high growth path for the long term, implying strong loans growth potential in the retail sector is not significantly leveraged.
As living standards improve with rise in per capita income, I see strong traction in the home loans segment and the auto loans segment. I must mention the Indian government has proposed low-cost housing for all by 2022, which will positively impact credit growth in terms of an increase in transaction volumes.
Conclusion
Unlike the banking sector in China, the Indian banking sector has maintained very strong fundamentals. HDFC Bank is among the top players in the industry with a healthy balance sheet. India is a fast-growing economy where the corporate and retail sectors are still not significantly leveraged. This provides room for the banking sector to grow from a core business perspective.
HDFC Bank will deliver stellar returns in the long term, making it a quality pick for long-term portfolios. The stock is attractive and should be considered at current levels.
Disclosure: No positions in the stock.
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