HDFC Bank Ltd – BUY (Target Price Rs2,259, Upside 28.7%)

Loan growth to strengthen further after stellar show in H1 FY10

HDFC bank has witnessed strong loan book expansion of 15% in H1 FY10, significantly higher than system (3.7%) and most other banks. More importantly, the growth has come despite a purposeful run-down in CBoP advances, now comprising only 5-6% of overall loan book. Recent growth has been solely driven by the corporate segment which grew by robust 35% in H1 FY10. The retail loan growth is set to revive from Q3 FY10 with the bank having witnessed record disbursements (~Rs30bn) in October 2009. We expect HDFC Bank’s loan book to grow by 26% in FY10 and 27% in FY11, materially ahead of the system growth in both years. 

NIM management has been exemplary; margin to remain stable

HDFC bank has managed NIM in a narrow band of 4.1-4.3% in the past 6-7 quarters despite heightened interest rate volatility, reversal in monetary stance by RBI, significant slowdown in credit demand, integration of relatively low-margin CBoP book and change in stand-alone advance mix. Through superior asset-liability management, the bank has consistently maintained the spread at 3.2%+. Despite a downward bias in lending rates, HDFC bank expects to maintain NIM at 4%+ in the near-term aided by re-pricing of significant term deposits during Q3 FY10.

Negligible restructuring and high provisioning imply least loan loss risk

Bank’s GNPLs declined by 6% in Q2 FY10 after increasing 1.4x in preceding five quarters. HDFC Bank has maintained NPL coverage at ~70%, one of the highest amongst private banks, thereby adequately covering the increase in GNPLs. The bank has negligible restructured assets at ~0.6% of advances, probably the lowest in industry. Also, consensus seems to be building about retail NPLs having largely peaked-out. Therefore, we expect further slippages, if any, would be minimal for the bank. GNPL % would remain stable or decline gradually over next 2-3 quarters.

Valuations at 3.6x 1-yr fwd rolling P/BV not expensive; re-rating towards 5x highly probable in credit upcycle 

In our view, HDFC Bank offering industry-best growth, profitability and asset quality is the best play in the ensuing credit upcycle. During the previous cycle (FY05-FY09), the bank traded at or above the current valuations of 3.6x 1-yr fwd rolling P/BV for a long time. We therefore believe that a re-rating towards 5x P/BV is impending as we proceed further in the new credit cycle. This could happen soon with the bank poised to deliver superior results than peers in next few quarters. Using our proprietary valuation model for banks, Bank 20, and an adjudged premium, we assign FY11 P/BV multiple of 4.6x and arrive at 1-yr price target of Rs2,259.