HDFC Bank (HDB, Financial) has been on my investment radar for a long time, and I last wrote a bullish article on March 20. Since then, the stock has moved higher by 30% and these are robust returns in six months.
Even as India’s economic growth remains relatively sluggish, I am bullish on HDFC Bank for more upside.
In addition to stock upside, HDFC Bank also pays a dividend of 51 cents, and the dividends will increase on a sustained basis in the coming years. This is another factor that can potentially trigger stock re-rating.
Healthy portfolio
I mentioned at the onset that even with relatively sluggish economic growth, HDFC Bank is likely to be a performer. One of the biggest concerns for India’s public sector banks currently is increasing NPAs.
The Reserve Bank of India has warned that India’s banking system’s gross bad loan ratio will rise to 10.2% of the total loan book in March 2018 from 9.6% in March 2017.
Amid this concern, HDFC Bank reported gross NPA of 1.05% in March and net NPA of 0.33% for the same period. This is among the best in the industry and positions HDFC Bank as a quality bank even as some public sector banks see NPAs rise above 20%.
Further, it is important to note that HDFC Bank has specific provision cover at 69% of NPAs and total coverage ratio of over 130%. Overall, the bank’s asset quality is healthy and even as the Indian banking industry witnessed challenges, I see HDFC Bank remaining an exception.
Healthy CASA
Another key factor that differentiates HDFC Bank from most other banks in India is the quality of deposit franchise. HDFC Bank has a healthy proportion of CASA (current and savings account) deposit.
In general, high ratio of CASA deposits does imply low funding cost and for HDFC Bank, the net interest margin has remained healthy at 4.3% for fiscal 2017.
The bank’s CASA is likely to remain strong in the coming years with HDFC having good rural and semi-urban penetration. As of March, 52% of the bank’s branches were in the semi-urban and urban areas.
With the banking sector penetration still low in these regions and the push toward digital transaction by the government, HDFC Bank stands to benefit in the future. I see the CASA ratio remaining stable or trending higher, and that is likely to ensure that the bank’s NIM remains among the best in the Indian banking industry.
Economic growth concerns
India has been facing economic headwinds in the recent past and with the banking sector in discussion, this aspect is critical to discuss. The major reason for near-term slowdown in GDP has been the exercise of demonetization followed by GST implementation.
Economists are of the opinion that GDP growth has bottomed out, and India’s growth will trend higher in the coming quarters. This can potentially ensure that HDFC Bank maintains healthy loans growth.
I also want to add here that for HDFC Bank, retail loans are critical for profitable growth and India’s retail sector is still not leveraged when compared to advanced economies or other emerging economies such as China.
As economic growth shows renewed traction, HDFC Bank can potentially trend higher on robust credit growth, and I see sentiments for the banking sector improving as NPAs stabilize or decline.
Conclusion
HDFC Bank reported other income (nonfunded revenue) at 27% of net revenues as of fiscal 2017. Fees and commissions constituted 72% of other income and with multiple fee sources; HDFC Bank has a stable visibility for nonfunded revenues. I see a steady increase in NFR with major sources being credit card fees and FX and derivative revenue.
Besides the balance sheet and CASA factors, HDFC Bank has been among the early movers in digital banking. As the usage of digital banking increases, the bank’s cost-to-income ratio is also likely to improve.
While HDFC Bank has moved sharply higher in the last six months, the stock still remains attractive from a long-term investment perspective. The Indian banking sector penetration remains significantly low, and this creates a big opportunity for established players to grow at a steady pace in the coming years.
Disclosure: No positions in the stock.
