HDB - HDFC Bank: Ride On India's Growth Story With Its Leading Bank

2023-04-24 02:23:16 ET

Summary

• In contrast to the West, India’s economy is thriving, a positive trend for the country’s banking sector.
• Housing activity is robust and long-term prospects are solid.
• Post-merger, HDFC Bank, India's biggest private sector bank, is better positioned to profit from India’s economic growth story.

India's largest private bank HDFC Bank ( HDB ) has delivered solid growth over the past decade with double digit growth in revenues and profits almost every year (except pandemic-hit FY 2021 when HDFC Bank delivered single digit growth).

HDFC Bank's continues to deliver robust performance; net profit rose 19.8% YoY to INR 120 billion for the quarter ended March 2023 while net profits for the full year ended March 2023 rose 20.8% to INR 530.8 billion.

Looking ahead, prospects are promising.

India's economy is on an upswing and the banks are poised to benefit

Amid anemic growth worldwide, India (along with China) remains as bright spots in the world economy with India expected to be the world's fastest-growing economy; the IMF predicts India's economy to grow 6.8% in FY 2024 from 6.1% in 2023, outpacing China (whose economy is projected to grow 5.2% in 2023 and 4.5% in 2024). Global economic growth meanwhile is projected at 3.1% in 2024. Long term prospects are just as positive; after overtaking the U.K. to emerge as the world's fifth largest economy, India is projected to surpass Japan and Germany to become the world's third biggest economy by 2029 .

The trend is positive for the Indian banking sector which is currently in good shape ; NPAs are at decade lows and profitability is improving across the board. The country's economic upswing could drive credit demand and there is plenty of room for long term credit growth; India's bank credit to GDP is just about 56% compared to 250% for the U.S. and 350% for Japan.

HDFC Bank, as the country's biggest private sector bank with operations in retail as well as wholesale banking (retail banking accounts for nearly 72% of revenues while wholesale banking accounts for 26.4% of revenues) is poised to benefit across several areas; personal loans and credit cards which accounts for a quarter of HDFC Bank's retail loan portfolio should benefit from growing consumer confidence and online spending ( more than 60% of credit card spend were made online and the Indian government's push to digitize payments could help increase credit card usage). Longer term, India's credit card spend is expected to grow more than 18% annually over the next few years, and with card penetration still being relatively low (India has 77 million active credit cards, more than the entire population of the UK, but translates into a 4.6% credit card penetration rate compared with 38% for China and 66% for the U.S.), card issuance should grow as well. The opportunity is significant for HDFC Bank, India's biggest credit card issuer.

Retail business banking loans which account for nearly a third of HDFC's Bank's retail loan portfolio should benefit from growing credit demand from MSMEs along with the country's economic upswing. Indian MSMEs account for nearly 50% of the country's exports and 30% of the country's GDP, but access to funding remains a challenge with the overall credit gap in India's MSME sector estimated at INR 25 trillion (approximately USD 300 billion) presenting a significant opportunity for HDFC Bank, India's second-biggest lender to MSMEs with an 18% market share (up from 12% two years earlier).

India's housing loan market is a significant growth opportunity and HDFC Bank is positioned to benefit

Despite rising interest rates India's housing market is thriving ; housing sales in the country's top 8 cities are at a 9-year high, and mortgage portfolios have expanded for India's top banks and non-bank financial institutions (NBFCs).

It remains to be seen if the market could sustain this momentum amid a climate of elevated interest rates near term, but long term prospects are promising; India's home loans which stood at around INR 24 trillion (approximately USD 290 billion) have grown 32% CAGR between FY 2017 and FY 2021. This is a pittance for India with its one billion plus population compared with the U.S. (300 million population) whose total residential mortgage balances exceed USD 11 trillion in 2022 indicating enormous room for growth.

India's home loan market is expected to double over the next five years (which translates into roughly 14% annual growth during the period) with the mortgage to GDP ratio rising commensurately from 11% currently according to a report by the State Bank of India. For perspective America's household debt accounted for around 66% of the country's GDP, again a reflection of India's vast untapped potential.

Housing loans have long accounted for a relatively small share of HDFC Bank's retail loan portfolio (housing loans account for just 9% of HDFC Bank's retail loan book little changed from a decade ago in 2012, when housing loans made up 10.6% of HDFC's retail loan book).

Part of this has to do with HDFC Bank being constrained in its ability to offer in-house housing loan products so as to avoid competing directly with parent company HDFC Ltd. That status quo however will change with HDFC Bank's merger with HDFC Limited. HDFC Ltd is India's largest housing finance company accounting for more than half of India's house buyers, and the merger would expand HDFC Bank's housing loan portfolio significantly; post-merger housing loans are expected to account for 33% of the combined entity's total loan portfolio (with the rest taken up by commercial and rural banking 24%, retail banking 21%, corporate banking 19%, and construction finance 3%) which means mortgages will be a significant revenue and earnings driver for HDFC Bank and the timing of the merger seems opportune considering the sector's long term prospects as well as the Indian government's crackdown on the shadow banking sector (which effectively negated the regulatory arbitrage advantage NBFCs had over banks) is resulting in housing finance companies ceding market share of individual housing loans to banks, a trend that has been playing out over the past few years; housing finance companies' market share in India's housing home loans exceeded 42% in 2018 but has dropped to 38% in 2022 while banks saw their share increase from 60% to 62% during the period.

With the merger, HDFC Bank has already acquired a significant share of India's home loans, as well as unrestricted freedom to offer housing loans as an in-house product (rather than as an agency product which may be less competitive and less profitable). Coupled with HDFC's expertise in housing loans (particularly in the affordable segment , a segment HDFC Bank has a very small exposure to, which presents a major opportunity for affordable housing financiers - India faces an affordable housing shortage, and affordable housing demand is growing particularly in smaller towns but the market is dominated by informal lenders which account for 95% of the market), HDFC Bank's access to lower-cost funding as well as HDFC's extensive and expanding branch network could potentially help the company capture more market share going forward amid ongoing market consolidation. HDFC already has the biggest branch network among India's private sector banks (far ahead of private sector competitors such as second-placed Axis Bank) and has been accelerating its deposit mobilization efforts (the bank's deposits grew 21% in FY 2023, far outpacing the industry average of around 10.3% for the year). The momentum looks set to continue with the bank planning to double its local branch network over the next three to five years by adding 1,500 to 2,000 new branches every year, an effort that should help support the bank's growth ambitions.

Cross selling opportunities post-merger

Over 70% of HDFC's customers do not bank with HDFC Bank which presents substantial opportunities to cross-sell products such as unsecured loans, and generate fees from lending and deposits, as well as products such as insurance and investment products. HDFC Bank earned fees and commissions of INR 202 billion (about USD 2 billion) for FY 2022, accounting for more than a fifth of total revenue for the year. Meanwhile about 5% of HDFC Bank's over 68 million customers do not have mortgages with HDFC Limited.

Near term challenges

Post merger the combined entity will be classified as a bank which may crimp the combined entity's near term profitability due to regulatory costs such as SLR and CRR costs (statutory Liquidity Ratio and Cash Reserve Ratio) post-merger.

Conclusion

HDFC Bank, one of India's most profitable banks looks set to capitalize on India's economic upswing post-merger with a well-balanced lending book that caters to housing, MSMEs, other retail borrowers as well as wholesale borrowers.

Analysts are bullish on the stock.

HDFC Bank currently trades at a P/E of 20 (slightly higher than ICICI bank which trades at a P/E of 17 ) which could be considered fair for a top tier bank with consistent double digit topline and bottom line growth, in a country with tremendous potential for economic expansion. Some may view the stock as a buy while others may view it as a hold.

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