1 March 2018 Update | Sector: Financials HDFC Bank

1 March 2018 Update | Sector: Financials

HDFC Bank

BSE SENSEX 34,047

S&P CNX 10,458

CMP: INR1,872

TP: INR2,400(+28%)

Buy

The juggernaut

Stock Info Bloomberg Equity Shares (m) 52-Week Range (INR) 1, 6, 12 Rel. Per (%) M.Cap. (INR b) M.Cap. (USD b) Avg Val, INRm Free float (%)

HDFCB IN 2,563

2014 / 1369 0/-1/18 5,023 77.9 3318.0 79.0

Financials Snapshot (INR b)

Y/E Mar

2018E 2019E

NII

409.5 484.7

OP

328.9 395.5

NP

175.8 216.4

NIM (%)

4.6 4.5

EPS (INR)

67.0 80.6

EPS Gr. (%)

18.0 20.3

BV/Sh. (INR) 473.8 538.2

ABV/Sh. (INR) 450.0 511.9

RoE (%)

16.2 15.9

RoA (%)

1.8 1.9

Payout (%)

21.1 20.2

Valuations

P/E(X)

27.9 23.2

P/BV (X)

4.0 3.5

P/ABV (X)

4.2 3.7

Div. Yield (%)

0.8 0.9

2020E 588.8 490.2 270.9

4.5 100.9

25.2 621.0 591.6

17.4 2.0

17.9

18.6 3.0 3.2 1.0

Shareholding pattern (%)

As On

Dec-17 Sep-17 Dec-16

Promoter

21.0 21.0 21.3

DII

12.2 11.6 12.4

FII

51.4 52.2 50.5

Others

15.4 15.1 15.9

FII Includes depository receipts

Stock Performance (1-year)

2,200

HDFC Bank Sensex - Rebased

2,000

1,800

1,600

1,400

1,200

HDFC Bank (HDFCBK) has consistently grown its market share in loans and deposits across credit cycles, and has emerged as the best-managed bank in India with robust profitability/growth metrics. Increasing granularity of the balance sheet, a focus on fee income growth, an improvement in operating leverage aided by digital initiatives, and controlled credit costs backed by strong underwriting have enabled the bank to outperform most peers. We expect the bank to maintain its growth momentum (regardless of its systemic size) and further gain market share across business segments. This, coupled with steady revenue growth, a continued improvement in operating leverage and moderation in credit cost, will help accelerate earnings growth (24% CAGR over FY18-20E). Moreover, its subsidiaries ? HDB Financial Services and HDFC Securities ? are rapidly gaining scale and will further support valuations. We expect HDFCBK to deliver RoA/RoE of 1.96%/17.4% in FY20E (RoE is suppressed as we have built in capital raise of INR240b). We maintain our Buy rating with a target price of INR2,400.

Market share gains to continue; No size too big Over the past 10 years, HDFCBK has steadily grown its loans/deposits market share to ~7.8%/ 6.4% of the system, driven by steady branch addition (up 7x from 684 in FY07 to 4,715 in FY17), improving employee productivity (business/employee doubled over FY07-17), and effective use of technology to gain distribution efficiency (cost-to-core income ratio decreased 840bp to 44.5% over FY07-17). The bank has also recorded the highest incremental market share among peers. We expect HDFCBK to continue gaining market share to reach 10% by FY22, driven by robust growth in the vehicle portfolio, business banking and unsecured segments.

Retail loan growth remains strong; working diligently to expand the pie HDFCBK has grown its retail book at a 27% CAGR over the past three years, significantly ahead of systemic retail loan growth. Enhanced focus on rural and semi-urban locations has helped the bank to gain strong traction in retail and SME loans. SME loan growth has also received a boost from digitization of the application process, which has reduced the turnaround time (TAT). While the share of unsecured personal and credit card loans has increased, the bank's credit monitoring framework remains robust, helping it maintain strong control on delinquency levels. The bank has 50%+ market share in the credit card business; it targets to double its outstanding card base over the next three years.

Robust third-party and bancassurance fees are driving overall fee growth HDFCBK has built a strong and well-diversified fee income profile over the years. While fee income forms ~1.2% of average assets and ~23% of total income, the contribution of third-party distribution to total fees has steadily increased to 16% from 11% in FY14. This was driven by a 14% CAGR in third-party fees over FY12-17.

Feb-17 May-17 Aug-17 Nov-17 Feb-18

Research Analyst: Nitin Aggarwal (Nitin.Aggarwal@); +91 22 3982 5540 | Anirvan Sarkar (Anirvan.Sarkar@); +91 22 3982 5505 Alpesh Mehta (Alpesh.Mehta@); +91 22 3982 5415 | Piran Engineer (Piran.Engineer@); +91 22 3980 4393

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

1 March 2018

HDFC Bank

Bancassurance income from HDFC Standard Life Insurance forms ~32% of HDFCBK's third-party distribution fees. HDFCBK continues to command >70% of total commissions paid by HDFC Life, which, coupled with strong new business growth trend for HDFC Life (43% growth over FY18YTD), provides visibility of robust fee income from this channel.

Operating leverage continues to surprise positively; digital initiatives help reduce sourcing costs The bank has channelled its digital abilities to reduce involvement of manpower in routine, process-driven operations, with an aim to enable employees to focus more on business generation. Initiatives such as 10-second personal loans and preapproved auto loans have helped reduce sourcing costs, leading to a steady improvement in cost-ratios. Over the past four years, the C/I ratio has improved by 450bp to 41%, and the cost-asset ratio by 31bp to 2.4%. We expect continued operating leverage improvement (38.4% cost-income by FY20E), led by (i) controlled employee/network growth, (ii) further improvement in branch productivity and (iii) lower operating expenses due to increasing usage of technology.

Subsidiaries rapidly gaining scale; expected to add ~4.3% to valuations Both HDB Financials and HDFC Securities have grown robustly over the last three years. While HDB Financials reached AUM of INR352b by 1QFY18 (comparable to CIFC), HDFC Securities recorded ~40% PAT CAGR over FY14-17, with its RoE improving to a healthy level of 29%+ from 22% in FY16. We expect both the subsidiaries to maintain strong growth trajectory over the next few years. At 25x FY20E earnings for HDFC Securities and 3.5x FY20E BV for HDB Financials, the two subsidiaries together would add INR103 to our TP, post hold-co discount of 20%.

Improvement in RoRWA underscores adequate pricing of risk; asset quality risks well in control Owing to stronger growth in the unsecured portfolio, the bank's RWA has steadily increased to 79% of total assets, indicating an increase in the risk profile. However, we note that besides the improvement in RoA (40bp improvement over FY11-18), the RoRWA of the bank has improved by ~30bp to ~2.5% during the same period. This indicates that ? (i) profitability has improved on the back of multiple levers (higher fee income and lower opex) rather than simply taking on higher balance sheet risk and (ii) the bank is able to adequately price the incremental risk it is taking via robust growth in the unsecured portfolio. The delinquency trend in the unsecured portfolio also remains well in control, given that >60% of credit card loans and >50% of personal loans are disbursed to existing customers with a strong credit history. HDFCBK's focus in extending these products largely to salaried customers also helps it in maintaining healthy asset quality.

Valuation view We expect HDFCBK to record 23% loan book CAGR and 24% PAT CAGR over FY1820E, with RoA/RoE of 1.96%/17.4% in FY20E (RoE is suppressed as we have built in capital raise of INR240b in our numbers). While margins may contract slightly due to intensifying competition, its robust fee income profile and strong control on operating leverage will continue driving a steady improvement in the return ratios (12bp improvement in RoA over FY18-20E). We arrive at a target price of INR2,400 (3.9x Mar'20E ABV and INR103 for subs) and maintain our Buy rating.

2

HDFC Bank

Market share gains to continue ? No size too big!

HDFCBK has consistently grown its market share in loans and deposits across credit cycles. The bank, thus, accounts for 7.8%/6.4% market share in loans/deposits v/s 2.4%/2.6% ten years ago. It ranks at the top amongst private players.

Market share expansion has accelerated over the past few years, led by continued traction across several product segments ? at a time when asset quality pressures have been impacting growth for many of its large private peers. The bank's loan book is now 25% higher than the closest private peer ICICI Bank, while the differential in the growth outlook will enable it to further widen its lead over the next few years.

Exhibit 1: Loan market share has increased to 7.8% for the bank

Credit market share 7.8

6.4 7.0 3.6 3.9 4.1 4.2 4.6 5.1 5.6 2.3 2.3 2.4 2.7

Exhibit 2: ...while deposits market share has increased to

6.4%

Deposit market share

5.9 6.0 6.4

5.3

3.7 3.7 4.0 4.2 4.4 4.8

3.2

2.6 2.6

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 3QFY18 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 3QFY18

Exhibit 3: Among major new private banks, HDFCBK has increased its advances market share to ~30%

HDFC Bank ICICI Bank Kotak Mahindra Bank

Axis Bank Indusind Bank YES Bank

Exhibit 4: ...while deposits market share has increased to 6.4%

HDFC Bank ICICI Bank Kotak Mahindra Bank

Axis Bank Indusind Bank YES Bank

6. 4 4. 8

6. 0 4. 5

5. 3 4. 2

3. 7 4. 5

2. 1 1. 9

5. 9 0. 8

1. 0 0. 0

3. 8 1. 3

1. 7 1. 5

58.8

36.7

30.1

24.6

23.9

10.0

21.1

21.9

25.9

24.5

16.4

25.5

28.4

29.3

29.9

FY05

FY10

FY15

FY17

9MFY18

3. 1 0. 6

1. 1 0. 6

3. 8 0. 9

1. 5 1. 1

FY05

FY10

FY15

FY17

9MFY18

3. 8 1. 2

1. 5 1. 3

Source: MOSL, Company

Source: MOSL, Company

Exhibit 5: Strongest credit market share gain among peers... Exhibit 6: ...as well as deposit market share

8.3 2.3

1.4

HDFC Bank credit market share ICICI Bank credit market share Axis Bank credit market share

5.6 3.9 3.2

5.6 5.9 4.3

7.0 5.9 4.7

7.8

6.2 5.2

5.9 2.1 1.9

HDFC Bank deposit market share ICICI Bank deposit market share Axis Bank deposit market share

4.5 3.7 3.1

5.3 4.2 3.8

6.0 4.5 3.8

6.4

4.8 3.8

FY05

FY10

FY15

FY17

3QFY18

Source: MOSL, RBI, Company

FY05

FY10

FY15

FY17

3QFY18

Source: MOSL, RBI, Company

1 March 2018

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HDFC Bank

While a few investors may have second thoughts on the long-term sustainability of this growth momentum given the increasingly bigger size of the bank, we believe that HDFCBK is well positioned to outgrow the system and further gain market share regardless of its size. We thus expect HDFCBK to attain 10% market share by FY22 while systemic loan growth also revives modestly.

Instead of just eating up into the market share from other banks, mainly PSU banks, HDFCBK has been able to expand the credit pie, with expansion of its network in sub-urban/rural geographies. This has helped the bank in maintaining uniform growth across its retail and wholesale segments ? in retail it is developing and capitalizing on new lending opportunities (given that PSU banks have limited presence in this segment to gain from), while in wholesale it is gaining market share both by way of refinancing and finding out fresh lending opportunities.

Well positioned to further strengthen its leadership across business segments

Auto loans to maintain healthy growth; used passenger vehicle mix gaining share: HDFCBK has grown its auto loan portfolio at a healthy 21% CAGR over the past three years, led by healthy traction in car/CV and auto loans. This was well supported by the increase in the share of used passenger vehicles, which now forms ~15% of the total passenger vehicle portfolio.

The shift from the unorganized to organized segment in the used PV market and the bank's targeted efforts into NBFC-dominated deeper geographies led by its stronger branch network are further enabling it to gain market share.

HDFCBK also aims to maintain strong growth trajectory in the CV portfolio. However, it does not plan to target the small CV segment very aggressively yet, as demand for MHCVs under the GST regime is likely to outpace that in lower tonnage vehicles. The bank, thus, is closely watching the developments in this segment, where some initial signs of strength are visible.

Exhibit 7: The bank has recorded robust growth in vehicles book from FY16

Car Loans (% growth) CV loans (% growth) 2 wheeler loans (% growth) 75.0

50.0

25.0

0.0

-25.0

Exhibit 8: Vehicle finance has declined as % of total book over the last few years

2 wheeler loans (% total loans) CV loans (% total loans) Car Loans (% total loans)

1.3 1.2 1.3 1.3

4.8

5.1

6.7

6.7

1.1 4.8

1.1 3.5

1.2 3.2

1.1 3.5

1.2 3.4

14.3 13.8 13.5 12.9 10.9 11.1 10.8 11.2 11.6

FY11 FY12 FY13 FY14 FY15 FY16 FY17 9MFY18 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 9MFY18

Source: MOSL, Company

Source: MOSL, Company

1 March 2018

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HDFC Bank

Unsecured portfolio to maintain growth momentum; asset quality trends remain strong: HDFCBK has delivered 39%/30% CAGR in the personal loans/credit card segments over the past three years. The share of unsecured loans in the total retail portfolio has thus increased 520bp over the past three years to reach ~30% (~16% of total loans).

Exhibit 9: Personal and credit card loans have recorded robust growth in last few years

Personal loans (% growth)

Credit Cards (% growth)

42.8

45.3

44.1

26.7 35.2

31.8 21.2

34.6

33.5

26.0

26.5

27.0

26.7

29.3

17.7

16.6

FY11

FY12

FY13

FY14

FY15

FY16

FY17 9MFY18

Source: MOSL, Company

Credit cards ? HDFCBK currently accounts for 29% of the total credit card market by both 9MFY18 POS transaction volume and transaction amount. This enables the bank to tie-up with multiple retail partners/brands and e-commerce companies, and offer attractive promotional schemes on purchases via its credit cards (e.g. cash backs on Apple i-phone purchase and discounts on purchase from Vijay Sales). This helps the bank in stepping up the customer acquisition run-rate and gain further market share.

1 March 2018

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