Markets
Three reasons HDFC Bank may turn around sooner than you think
Summary
- HDFC Bank hit an all-time high of ₹1,830, driven by superior asset quality, reducing LDR post-merger, MSCI inflows, mutual fund buying, and attractive valuations, signalling potential outperformance ahead.
HDFC Bank shares hit an all-time high of ₹1,830 apiece on 28 November. After trading in the ₹1,300- ₹1,700 range for nearly four years, a breakout in high volumes could be a telling sign.
Here are three key reasons why HDFC Bank might be gearing up to outperform the index.
Asset quality
HDFC Banks’ asset quality remains the best in class. Its credit cost was also the lowest amongst peer groups in the September quarter.
Although the gross NPAs of SBI, ICICI Bank and Axis Bank have declined marginally, their gross bad assets remain significantly higher than HDFC Bank. We also believe that in a generally poor credit environment, HDFC Banks’ asset quality is likely to remain relatively superior, as it has been over the past many cycles. This would warrant a superior valuation.
But while low NPAs compared to peers is desirable, it must translate into healthy return on equity (ROE) and earnings per share (EPS) growth. This has not been the case lately. In fact, credit growth and profitability have slowed down to 10.2% year-on-year compared to system-level growth of 13%.
The primary reason for this slowdown is a high loan-to-deposit ratio (LDR), which HDFC Bank is actively working to reduce.
LDR coming down
The bank's LDR was around 86-87% prior to its merger with parent HDFC Ltd in July 2023. Post the merger, it rose as high as 110% after the merger. This posed a unique problem for the bank.
A high LDR implies that an incremental loans are funded by borrowings, not deposits. The primary reason for a high CD ratio (79.6%) on the system level is that deposit growth in the system is unable to meet the demand for loans. To attract deposits, banks must raise interest rates or borrow from costlier sources. This raises the cost of borrowings and hurts net interest margins (the gross margin of banks). Lower net interest margins mean lower profitability and lower return on equity.
In the September 2024 analyst concall, CEO Sashi Jagdishan said, "We aim to reduce the CD (Credit to Deposit) ratio more quickly than initially expected. By FY26, we could align with the system growth rate, and by FY27, we anticipate exceeding it."
From an earlier stated timeline of four-five years for bringing down the LDR to 80-85%, the bank now expects to achieve the same in two-three years. And it’s not all talk. The bank has sold loans of around ₹24,600 crore so far since March. The LDR now stands at 100.8%, down from 104% a quarter earlier.
Also Read: Patience vs Payoff: What HDFC Bank’s investors can learn from Sachin Tendulkar
Anticipated fund-flows
While fund-flows are temporary and volatile, two major sources of fund flows may explain the recent buoyancy in the HDFC Bank stock.
MSCI Inclusion
Morgan Stanley Capital International (MSCI) is a global stock tracker that helps investors decide where to invest. Companies on its list attract more money as many funds follow it to pick stocks.
The MSCI rebalancing is projected to bring approximately ₹15,000 crore in inflows, which happened in August 2024. Another ₹15,700 crore of inflows were expected during the second tranche. This influx is primarily due to HDFC Bank's increased weight in the MSCI Global Standard Index, which will enhance its attractiveness to passive investors who track these indices. The second tranche was effective 25 November 2024 onwards.
As a result of these changes, HDFC Bank's weight in the MSCI Emerging Markets Index rose significantly—from around 3.8% to potentially 7.2-7.5% after the adjustments. This has likely boosted demand for HDFC Bank shares.
Mutual fund buying
In October 24, mutual funds bought an additional 3.4 crore shares with net inflows of ₹5,900 crore. It’s likely that MF were net buyers in November 2024 too, although the data is not available at time of writing this article. The number of funds holding HDFC Bank has also increased since May 2024.
Undervaluation
The price to book has improved from 2.8x in September 2024 to 3.1x in November 2024. Therefore, the extent of undervaluation on a 10-year median P/B basis has reduced.
10-Year Price/Book chart – HDFC Bank
On a P/E basis too, the undervaluation compared to a few months back has reduced but remains relatively undervalued to Nifty 50 in our opinion.
10 Year Price/Earnings Ratio Chart -HDFC Bank
HDFC Bank trades at P/E of 20.8x, while Nifty trades at 22.2x.
A bank with an earning profile that is much more stable than most Nifty constituents must trade at a premium not a discount. Obviously, growth has been a concern but that is getting resolved. The future might be kinder to HDFC Bank shareholders. Only time will tell…
Also Read: Nifty may retest its all-time high level. 3 stocks to lead the rally
Note: We have relied on data from www.Screener.in and www.tijorifinance.com throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.
The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only.
Rahul Rao has been investing since 2014. He has helped conduct financial literacy programs for over 1,50,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.
Disclosure: The writer and his dependents hold shares in HDFC Bank discussed in this article.
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