May 25, 2009 | Banking

Initiating Coverage

HDFC Bank (HDFBAN)

Stable & consistent delivery of quality
HDFC Bank has historically traded at premium multiples due to its strong deposit franchise, stable earnings growth, reputed management and high RoE. However, the challenging economic environment will moderate growth momentum and pose challenges, going ahead. We expect the balance sheet to grow at 17% CAGR over FY09-FY11E to Rs 2,52,921 crore. We are initiating coverage on the stock with a HOLD rating.

Current Price Rs 1366 Potential upside 6%

Target Price Rs 1434 Time Frame 12 months

HOLD
Analysts Name Kajal Jain kajal.jain@icicidirect.com Chirag Shah chirag.shah@icicidirect.com Viraj Gandhi viraj.gandhi@icicidirect.com NII trend
(Rs Crore) 12000 7000 2000 FY08 FY09 FY10E FY11E 5228 7499 9074 10416

Business momentum moderating Aims growth coupled with profitability

We expect the merged entity to grow its advance book by 21% CAGR to Rs 145757 crore and deposit by 19% to Rs 202282 crore by FY11E. The merger has helped HDFC Bank gain market share, which is nearly 4% now. We believe HDFC Bank will retain its market share, going ahead as well. The growth in advances should lead to NII growth of 18% CAGR over FY09-FY11E to Rs 10416 crore. This, in turn, should lead to a PAT growth of 25% CAGR to Rs 3497 crore by FY11E.

Liability franchise (CASA) to provide shelter to maintain NIMs

Historically, HDFC Bank has managed to garner CASA of above 50% but the ratio has now moderated to 44% in FY09 due to the merger. We believe the underleveraged branches of CBoP will shore up to HDFC Banks level from FY10E. Hence, we expect CASA mobilisation to start inching up again and reach 48% by FY11E. This will help the bank to maintain NIMs of over 4% in the coming years as well.

Stock Metrics
Bloomberg Code Reuters Code Face value (Rs) Promoters Holding Market Cap (Rs cr) 52 week H/L Sensex Average volumes HDFCB IN HDBK.BO 10 19% 57937 1540 / 774 13886 1538386

Valuations
At the CMP of Rs 1366 the bank is trading at 3.1x and 2.9x its FY10E and FY11E ABV, respectively. We expect HDFC Bank to be able to generate RoEs in the range of 15-16% over the next two years. After considering three possible scenarios of capital raising via warrants conversion (Exhibits 31 to 33), we value the bank at original conversion price of Rs 1520. Thereby, we have arrived at FY11E fair ABV of Rs 478. We value the stock at 3.0x FY11E ABV to arrive at a target price of Rs 1434. We recommend a HOLD rating on the stock. Exhibit 1: Key Financials
Year to March Net Profit (Rs crore) EPS (Rs) Growth (%) P/E (x) Price / Book (x) Price / ABV (x) GNPA (%) NNPA (%) RoNA (%) RoE (%) FY08 1590.2 44.9 25.5 30.5 4.2 4.3 1.4 0.5 1.4 17.7 FY09 2245.0 52.9 17.8 25.9 3.9 4.2 2.0 0.6 1.3 17.0 FY10E 2809.1 66.2 25.1 20.7 3.4 3.7 2.7 1.1 1.4 17.6 FY11E 3497.0 82.4 24.5 16.6 3.1 3.3 2.5 0.9 1.5 19.4

Comparative return metrics (%)

Stock Returns Axis Bank HDFC Bank Kotak bank Yes Bank 3m 87 55 162 134 6m 79 67 127 101 12m -16 -3 -12 -21

Price Trend
1900 1600 1300 1000 700 Nov-08 Aug-08 Dec-08 Sep-08 Mar-09 Feb-09 Apr-09 Jul-08 Jan-09 Oct-08

Close Price

Absolute Buy Target Price

Source: Company, ICICIdirect.com Research

Absolute Sell

ICICIdirect | Equity Research

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Company Background
HDFC Bank, a new-generation bank, is the second largest privatesector bank, which received a banking licence in 1994. Housing Development Finance Corporation (HDFC) promoted the bank to capitalise on the opportunity provided by the Reserve Bank of India (RBI) as it opened up the banking industry to private players. Exhibit 2: Expansion in distribution platform
FY09 FY08 FY07 FY06 761 684 535 1184 1000 2000 3000 4000 5000 1412 1977 3295

Shareholder Promoters Institutional investors Other investors General public

% holding 19.4 39.6 8.8 32.3

Promoter & Institutional holding trend (%)

50 40 36.6 38.0 39.6

33.6

(%)

1605 1323

30 20 10 19.4 19.4 19.4 19.4

FY05 256 0

Q1
Promoter Holding

Q2

Q3

Q4

Institutional Holding

Branches
Source: Company, ICICIdirect.com Research

ATM

Exhibit 3: Historical growth in business

90 70 50 30 10 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 34 38 37 47 51 50 39 27 (%)

73 51 36 41 29 20 58 44 53 37 47 48 34 22 27 35 42 42 48

Advances

Deposits

Total Business

Source: Company, ICICIdirect.com Research

Key financial highlights for FY09

Total income grew by 58.2% to Rs 19623 crore Net revenues (NII + other income) growth of 42.6% to Rs 10712 crore NIM (reported) @ 4.2%, CASA @ 44.4% Net profit grew 41.2% to Rs 2245 crore Balance sheet size stood at Rs183271 crore Deposits Rs 142812 crore, advances Rs 100239 crore CAR @ 15.7%, Tier I @ 10.6% GNPA @ 2.0%, NNPA @ 0.6%

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Investment Rationale
Business momentum moderating Aims at growth coupled with profitability Market share: On the up move
The merger with Centurion bank of Punjab (CBoP) has enabled the bank to enjoy higher market share. HDFC Bank had 2.3% market share in FY06 of the total credit outstanding in the system for scheduled commercial banks, which improved gradually to 2.7% in FY08. This went up to 4% by the end of June 2008 (first merged results). Similarly, the share of deposits went up from 2.6% in FY06 to 4.0%. We expect the merged entity to grow its advance book by 21% CAGR to Rs 145757 crore and deposit by 19% CAGR to Rs 202282 crore by FY11E. The expanded distribution network of 1421 branches will support these growth projections, going ahead. Exhibit 4: Market share on the rise

HDFC Bank added 660 branches in FY09 to take its tally to 1421 branches from 761 in FY08. This will help the bank to grow its deposits base by 19% CAGR over FY09FY11E

5 4.0 3.2 2.7 2.3 90858 2 FY06 FY07 FY08 Q1FY09 Q2FY09 Q3FY09 FY09 2.6 2.4 115243 227715 164196 4.0 4.0 241601 4.0 3.8 245554 3.8 3.8 243068

240,000

(%)
3

160,000

(Rs crore)

80,000

Total Business (RHS)

Source: Company, ICICIdirect.com Research

Advances

Deposits

The merger has enabled HDFC Bank to capture higher market share even in tough conditions

In an industry where all other major players like BoI and PNB are either consolidating or inching up their market share slowly, HDFC Bank is actually strengthening its position in the industry mainly due to the merger. Exhibit 5: Market share in advances
40.0 5.1 3.8 5.2 18.9 5.2 3.9 5.3 19.6 FY09 5.3 3.8 5.4 20.0

Exhibit 6: Market share in deposits

40.0 5.0 3.7 5.2 19.4 FY09 4.9 3.8 5.3 19.7 FY10E

30.0

20.0

4.4 2.4 5.0 17.5

4.8 2.7 5.1 17.7 FY08

5.1 4.0 4.8 18.5

5.1 4.2 5.1 17.7

30.0

4.6 2.6 5.4 16.8

4.7 3.2 5.2 16.8 FY08

4.9 4.0 5.3 17.1

4.8 3.9 5.4 18.0

4.7 4.0 5.4 18.2

(%)

10.0 FY07 Q1FY09 Q2FY09 Q3FY09 FY10E

(%)
20.0 10.0

FY07

Q1FY09 Q2FY09 Q3FY09

SBI

PNB

HDFC Bank

BOI

SBI

PNB

HDFC Bank

BOI

Source: Company, ICICIdirect.com Research Growth assumption for FY10E Deposit-17%, advances-18%

Source: Company, ICICIdirect.com Research

Market share calculated only for scheduled commercial banks.

3 | Page

Liability franchise (CASA) to provide shelter to maintain NIMs

Low cost deposits (CASA) will prove important, going ahead, for the bank to maintain NIMs of above 4% levels. The deposits for HDFC Bank grew at a CAGR of 37% for FY06-09. Deposits are always in the range of 70-75% as percentage of total liabilities for the bank over the years. This shows great dependence on liability franchise for growth. Hence, higher CASA mobilisation will always be on the top of the agenda for this bank in FY10E. Exhibit 7: Deposit mobilisation momentum continues
275000 225000 46.0 252922 47.5 37.6 214717 41.7 168228 24.1 133176 22.4 100768 55796 73506 68297 91235 142812 183271 202282 50 40 30 17.8 20.2 10 FY09 FY11E 20

(Rs crore)

125000 75000 25000

17.2 17.8

Deposits

FY06

FY07

FY08

T.Liabilities

FY10E

Deposit growth (RHS)

T. liab growth (RHS)

Source: Company, ICICIdirect.com Research

CASA accumulation was the strongest point for HDFC Bank historically. It has maintained its CASA ratio of over 50% for years. The merger of CBoP and the rising interest scenario in H1FY09 resulted in a deceleration in CASA from over 50% to 40% by December 2008 and inching back again to 44% by March 2009. The economic scenario is now changing rapidly and interest rates are heading southwards again due to falling inflation. This will reduce the mounting gap between term deposits and saving deposits. Inflation for the week ended April 24 2009 was 0.6% against a peak of 13% odd earlier in August 2008. Therefore, this should help in garnering CASA for the coming year. We expect CASA of 48% for FY11E. Exhibit 8: Deposit mix
230000 205000 180000 155000 130000 105000 80000 55000 30000 5000 28765 26154 FY08 45850 28445 54.5 26929 44.9 26123 44.0 24258 40.0 44.0 31853 Q1FY09 32794 Q2FY09 33081 34915 FY09 Q3FY09 35896 72136 74917 87523 89231 43697

(%)

175000

CASA trending downwards is a cause for worry. However, we believe this phenomenon will be short lived and the bank will again inch up the CASA level in FY10E and expect it to be 48% for FY11E

CASA %

(Rs Crore)
90433

104956

46.2
41898 FY10E

48.1
53629 FY11E

Saving
Source: Company, ICICIdirect.com Research

Current

Term

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Reasons behind maintaining high CASA ratio for HDFC Bank Diversified branch network: Almost 60% of the combined branches are located in the CASA rich northern and western regions of the country HDFC Bank mops up substantial free float generated by its transactional banking service like cash management, stock exchange clearing, plays the role of a banker to many IPOs, collecting banker to many mutual fund schemes, correspondent banking service, salary accounts and tax collections Exhibit 9: Branch distribution
HDFC Bank 18% 28% 42% 34% 34% 28% CBoP 8% Combined 16%

There is no single big contributor to CASA for HDFC Bank. Hence, this gives consistency and lower risk, going ahead

22% 32% 16%

East

South West

North

28%

Source: Company, ICICIdirect.com Research

Lower risk in CASA mobilisation, going ahead The well-diversified resource mobilisation scatters the risk and mitigates the impact of any one segment suffering on the overall CASA pie. However, in the near term, integration of CBoP will lead to a lowering of CASA, as most of the branches of CBoP are underutilised. This, coupled with an increase in demand for term deposits, has pulled down the CASA in FY09. The banking sector, as a whole, has substantially increased the rates on deposits in H1FY09. This, in turn, has affected the CASA generating capacity as well as the margins of the bank across the sector. However, we believe a bank like HDFC Bank will stand out as it has always maintained a leadership position in CASA accretion. This was quite evident from the FY09 results where HDFC Bank reported a healthy CASA of 44% (consolidated figure), which is still very competitive in the industry. Exhibit 10: CASA mobilisation: Trending down but still competitive
60 50 (%) 40 30 20 FY06 FY07 FY08 FY09 40 38 55 48 40 35 33 32 31 31 58 48 46 54 47 43 44 39 30 31

Though CASA is trending downwards post merger, HDFC Bank is still the leader in the industry

Axis bank

BOB

BOI

HDFC bank

SBI

Source: Company, ICICIdirect.com Research

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Going forward: Further CASA generation from erstwhile CBOP branches We believe there is a substantial opportunity for HDFC Bank to create value by shoring up the underleveraged CBoP branches. We expect these branches to scale up the operations by FY10E. Before merger, CBoP branches garnered only 20% of the CASA garnered by HDFC Bank. However, the merged entity reported CASA of 44% for FY09. Going ahead, we feel the bank will be able to create value by accumulating more CASA from erstwhile CBoP branches, thus keep a check on cost of funds, and maintain NIMs (reported) above 4%. Exhibit 11: CASA per branch: Scope for improvement
100.0

80.0

(Rs Crore) .

60.0

40.0

Substantial scope for improvement

20.0 FY06

FY07

FY08A

HDFC Bank

CBoP

Source: Company, ICICIdirect.com Research

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Net Interest Income (NII) to grow at modest 15% CAGR over FY09-FY11E
We believe the well-balanced approach between the corporate and the retail book coupled with the acquisition of CBoP will help the bank to witness consistent growth in the net interest income. We have forecast moderate 18% CAGR in NII over FY09-FY11E at Rs 10416 crore supported by advances and deposits growth of 19% and 21% CAGR, respectively. The ability to garner high CASA will help the bank to control its cost of funds and, thereby, help the bank in maintaining NIMs (reported) of over 4%. Margins to be maintained around 4% The bank has reduced its deposits rate by almost 150 bps in the recent past and BPLR by just 50 bps. Lately, due to the high interest rate scenario demand for term deposits was on the rise, which could have influenced NIMs for the bank. However, we believe a higher CASA ratio coupled with deposit rate cuts should help in maintaining NIMs (calculated) above 4%, going ahead, as well. This will still be higher than the industry average of 3%. Exhibit 12: NIMs (calculated) maintained above 4%
12 10 8 7.5 5.3 6.1 5.6 5.4 9.5 8.5 9.4 9.4 9.1

(%)
6 3.7 4 2 FY06 4.5 FY07

4.7

4.9

4.3 FY09

4.7

4.6

FY08

FY10E

FY11E

Yield on Advances

Cost of Funds

NIMs (calculated)

Source: Company, ICICIdirect.com Research

Exhibit 13: NII trending northwards

11,000 9,074

10,416

(Rs Crore)

9,000 7,000 5,000 3,000 1,042 1,000 Q1FY08 Q2FY08 Q3FY08 Q4FY08 FY08 Q1FY09 Q2FY09 Q3FY09 1,163 1,438 1,642 1,723 1,867 1,979

7,421 5,228

FY09

FY10E

FY11E

Source: Company, ICICIdirect.com Research

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Non-interest income: One of the key drivers of profitability

We expect non-interest income to grow at a moderate pace of 16% CAGR over FY09-FY11E to Rs 4393 crore. The main driver for non-interest income for HDFC Bank is commission and brokerage (CEB) income i.e. fee based income that the bank generates from the distribution of third-party products like mutual funds and insurance, fees on debit/credit cards, transactional charges, processing fees of retail assets, cards and trade products and from originating home loans for HDFC. The other arm, which contributes to other income, is profit on sale/revaluation of investment and foreign exchange and derivatives revenue. The non-interest income grew @36% CAGR over FY06-09 fuelled by CEB growth of 33%for the same period. We expect the growth to moderate in the coming years. We have modelled in modest 20% CAGR growth in CEB over FY09-FY11E to Rs 3539 crore. Exhibit 14: Contribution of CEB to non-interest income
5000 4500 4000 3500 3000 2500 2000 1500 1000 500 20% CAGR 4393 30% CAGR 2283 1045 1124 1292 1516 1715 2457 3797 3291 2949 3539

(Rs Crore) .

605

651

FY05

FY06

FY07

FY08

FY09

FY10E

FY11E

Commission, Exchange, Brokerage

Total

Source: Company, ICICIdirect.com Research

We expect some moderation in third-party distribution of mutual funds and insurance products due to the slowdown in financial markets. So, we have modelled in 20% CAGR over FY09-FY11E. Exhibit 15: Third-party distribution of MF Exhibit 16: Third-party distribution of insurance

45000 Mutual Funds 21000 33000

700 Insurance 380 500

(Rs crores)
10000 20000 30000 40000

.
50000

(Rs crores)
100 200 300 400 500 600 700

.
800

FY06

FY07

FY08

FY06

FY07

FY08

Source: Company, ICICIdirect.com Research

Source: Company, ICICIdirect.com Research

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The merger of CBoP augurs well for HDFC Bank for the distribution business since the merger provides HDFC Bank with an expanded distribution network and around 3 million additional customers. The remittance business is also expected to pick up since around 114 branches of CBoP are located in Kerala and Tamil Nadu where the remittance business is comparatively high. The bank originates home loans under its arrangement with HDFC with monthly origination crossing Rs 550 crore by the end of March 2008. We expect lower origination growth for FY10E due to the slump in the retail sector to around Rs 600 crore on a monthly basis. The bank earns 1% as the origination fee on the amount of origination for such arrangements. The bank also has the right to exercise its option to take any part of 70% of the loan origination into its books. The bank has not exercised this option anytime in the previous years. Exhibit 17: Cash settlement volumes on Indian bourses
40000 35000 38000 30000 30000 25000 20000 15000 10000 5000 0 FY06 FY07 FY08 36000

Exhibit 18: Cash management volumes

30000 25000 25000

(Rs Crore) .

(Rs Crore) .

20000 15000 10000 5000 0 FY06 FY07 10000 12500

FY08

Source: Company, ICICIdirect.com Research

Source: Company, ICICIdirect.com Research

HDFC Bank is one of the largest players in the cash management and settlement business on stock and commodities exchanges in India. This coupled with strong growth in the transaction banking vertical and welldiversified fee income supports well when there is some kind of moderation in financial activities. However, we believe HDFC Bank is performing well on all fronts like its multiple delivery channels, proper positioning and cross selling of products across the retail and corporate segments. The business verticals of CBoP will also add to the non-interest income.

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Asset quality to stabilise next year

Exhibit 19: A blip in asset quality post merger
3 2.5 2 1.9 1.3 1.5 1.6 1.1 0.5 0.6 0.6 0.6 2.0 2.7

2.5

1.5 1 0.5 0

1.2

1.2

0.9

0.4

0.4

0.4

Asset quality of HDFC Bank is deteriorating because of the merger. CBoP had a big exposure to the auto sector and mortgage portfolio. We, therefore, have factored in higher NPA for FY10E but prudent provisioning norms will keep a check from FY11E onwards

(%)

FY06

FY07

FY08

Q1FY09

Q2FY09

Q3FY09

FY09

FY10E

FY11E

GNPA
Source: Company, ICICIdirect.com Research

NNPA

The asset quality of the bank is under pressure because of the CBoP merger, since the asset quality of CBoP was not as healthy as compared to HDFC Bank. The reported figures for GNPA were 2.0% during FY09. On the other hand, due to rising interest rates there was an upward pressure on NPA levels across the industry. On an immediate basis, stressed retail loan book may cause higher NPLs. Of these retail assets, personal loan and credit cards form only 13% of the total advance book. We feel NNPA should stabilise in the range of 1.0-1.1% by the end of FY11E since loan loss provisioning for HDFC Bank is always in the range of 70-75% for HDFC Bank. Exhibit 20: Retail loan book for FY09 Total restructured assets as of March 31, 2009 were Rs 120 crore of which Rs 69 crore were already classified as NPAs
Auto (Including TW, CV), 42%

others, 12%

Business Banking, 22% Loan against Sec, 2%

In addition, applications received for loan restructuring which were yet to be approved or implemented amounted to Rs 305 crore, of which Rs 254 crore was classified as NPAs. Total standard assets which have been restructured or where restructuring is under consideration were therefore, 0.1% of the banks gross advances as of March 31, 2009

Credit cards, 7%

Personal, 15%

Source: Company, ICICIdirect.com Research

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Merger with CBoP: Value accretive in the long run

Growth coupled with quality: Adhering to its philosophy, HDFC Bank went on to acquire Centurion Bank of Punjab (CBoP) thereby creating the seventh largest banking entity in India in terms of balance sheet size. The deal was a share swap deal wherein 29 shares of CBoP fetched one share of HDFC Bank. The deal amount and valuation offered took many by surprise. In short, the deal was EPS accretive in FY09 but will definitely be value accretive from FY10E due to network expansion. The merger was EPS dilutive in FY09 but is expected to be EPS accretive from FY10E onwards

Modalities of the merger: The price paid

Nearly seven crore shares of HDFC Bank were allotted pursuant to a share swap ratio of (1:29). This translated to one equity share of HDFC Bank of Rs 10 each for every 29 shares of CBoP of Re 1 each, as on June 16 2008. Thus, HDFC Bank paid a sum of Rs 8050 crore to acquire CBoP, thereby valuing the latter at 4.1x its 9MFY08 BV. Exhibit 21: Valuation matrix
No of shares (crore) Closing price of HDFC Bank (16/06/2008) Amount paid (crores) Book Value (Rs crores) No of times book value (x)
Source: Company, ICICIdirect.com Research

7.0 1151.0 8043.6 1963.3 4.1

Exhibit 22: Dynamics : Business per branch

250 216 200 150 112 100 60 50 0 Business/ branch of HDFC Bank Business/ Branch of CBoP FY07 FY08 FY09 Expected business/branch of the merged enitity FY10E 1+1 > 2 168

Value creation
172

238

Source: Company, ICICIdirect.com Research

Branch valuation Exhibit 23: Branch valuation

No of shares (crores) Closing price as on 16/06/08 Amount paid (Rs crores) No of Branches Acquisition cost per branch (Rs crores) Market Cap/branch of HDFC Bank (Rs crores)
Source: Company, ICICIdirect.com Research

7.0 1151.0 8043.6 394.0 20.4 53.5

11 | Page

The amalgamation added significant value to HDFC Bank in terms of increased branch network, geographic reach and customer base and a bigger pool of skilled work force, which would have taken a few years to grow organically. This will help the bank to garner more retail deposits and thus reduce upward pressure on the cost of funds, which will be the key in challenging times ahead. The swap ratio turned out to be more positive for HDFC Bank than expected. As we see it, it seems that HDFC Bank has paid higher to acquire 394 branches of CBoP. However, when we look at the acquisition cost per branch as compared to what the market is valuing each HDFC branch at, it accounted for only 38% of its value then. However, in our view all the under leveraged branches of CBoP will shore up to HDFC Banks standard in FY10E. Hence, the merger will be EPS accretive in FY10E. Until then it will be dilutive. Exhibit 24: Merged entity with a much wider reach
4200 3177 2890 2526 2200 1229 1200 684 761 316 200 Branches ATM Cities 324 444 1412 1412 1412 1605 1977 3295

3200

528

527

528

2007

2008

Q1FY09 (Post Merger)

Q2FY09

Q3FY09

FY09

Source: Company, ICICIdirect.com Research

CBoP had 20% of total assets compared to the size of HDFC Bank by the end of December 2007, despite having 52% of the branches (394). The business per branch was only 40% on a comparative basis for CBoP. However, in the first merged results, we can see that business per branch is closer to HDFC Banks level, which is where we see value creation. This was the trend in the next two quarters as well. Exhibit 25: Merger dynamics
Rs Crore Parameters Advances Deposits Total Assets Branches Business/branch NIM (%) CASA (%) HDFC Bank Q3FY08 71387 99387 131439 754 226 4.3 50.9 CBoP CBoP as % of Q3FY08 HDFC Bk 15083 21.1 20710 20.8 25404 20.0 394 52.3 91 40.1 3.6 24.5 Q1FY09 96797 130918 168598 1221 186 4.1 44.9 Merged Results Q2FY09 Q3FY09 107820 100682 133781 144862 171765 183185 1412 1412 171 174 4.2 4.3 44.0 40.0 Q4FY09 100239 142812 183271 1412 172 4.2 44.0

Source: Company, ICICIdirect.com Research

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Risks & Concerns

Economic slowdown can affect growth and asset quality
RBI has shifted its focus from curbing inflation to economic stability and growth. Inflation, which was around 12-13% at the beginning of CY08 is now again in the low single digits. Despite recent rate cuts, we do not see a faster credit off take, particularly private banks. Banks are hesitant to lend to certain sectors where stress is visible like real estate, gems & jewellery, exports, autos, textiles, etc. If the slowdown continues, the estimated business growth may fall for system and for HDFC Bank as well. In the slowing economic scenario, we can see some up tick in NPA levels across the industry. Retail as a percentage of total advances for HDFC Bank is around 60%. This segment can suffer if we witness a further slowdown in growth and earnings.

Excessive dilution to drag RoE

Post 2008, shareholders of CBoP were allotted 6.98 crore shares based on swap ratio resulting in dilution of almost 20%. If we consider the conversion of warrants, already allotted to HDFC in FY10 then there will be further dilution of 6% from these levels. Any further dilution, going ahead, for capital requirement may affect the RoEs adversely.

Risk of premium multiple shrinking

Inability to maintain higher than industry CASA and deliver consistent profits in future as delivered in the past may result in shrinking of premium multiple received by the bank.

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Financials
Total net income growth pegged at 15% CAGR over FY09-FY11E
Net Interest Income (NII) and non-interest income has grown at 46% and 36% CAGR over FY07-09 period taking total income growth at same level. Going ahead, with pressure on advances growth and falling interest rates we anticipate NII to grow at 18% CAGR over FY09-11E to Rs 10416 crore. However, lower treasury gains and fee income will result in moderate 16% CAGR growth in non-interest income leading to total net income growth of 18% CAGR over the same period to Rs 14083 crore. We have seen that more than 55% of the revenues came from traditional banking transaction that is interest income. CEB (fee income) as a percentage of total income is picking up momentum. On the expense side, operating expense contributed only at 32% of the total expenses, which shows cost efficiencies built in the system for the bank. However, after the merger of CBoP we have factored in that the operating cost will rise for the merged entity in the coming years. Exhibit 26: Rupee earned for FY08
Profit on Investment, 2% CEB, 14% Forex, 3% Int from advances, 56% Operating Expense, 32% Interest Expense, 42%

Exhibit 27: Rupee spent for FY08

Tax, 6%

Provision, 13% Dividend, 3% Trans to Reserve, 5%

Interest from Investment, 23% Other int income, 2%

Source: Company, ICICIdirect.com Research

Source: Company, ICICIdirect.com Research

Profitability moderating
We revised PAT @25% CAGR during the next couple of years slightly moderating from historical trend of 30%. The bank has reported a CAGR of 38% in PAT for FY99-08. This shows the consistency with which the bank has made inroads into the under banked economy of India. We expect provisions to rise steeply by 66% in FY09E due to CBOP merger and its old NPAs. We expect the banks prudent growth norms to keep provisioning under control and, hence, bring bottomline growth back on track. Exhibit 28: PAT growth: to moderate in the coming year
4000 3497 2809 CAGR @44% 665 870 1141 1590 2245

(Rs Crore)

3000 2000 1000 0 FY99 FY00 FY01 FY02 FY03 82 120 210 297 387

509

FY04

FY05

FY06

FY07

FY08

FY09 FY10E FY11E

Source: Company, ICICIdirect.com Research

14 | Page

Payout ratio
The EPS for the bank has been on the rise right from FY98 when the bank reported EPS of Rs 4.1. By the end of FY08, it went all the way to Rs 46.2. The growth for the bank was always steady and the payout ratio for the bank has always been in the range of 20-25%. We feel dividend payout ratio will stay at current levels to keep a balance between growth and returns to shareholders. Exhibit 29: Movement in EPS, DPS & payout ratio
90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 77.6 22.9 24.0 22.9 4.5 22.6 36.3 27.9 5.5 7.0 46.2 22.2 8.5 62.3 52.8 23.9 20.9 12.6 13.0 20.9 16.2 30 25 20 15 10 FY05 FY06 FY07 FY08 FY09 FY10E FY11E

(Rupees)

EPS

DPS

Payout ratio (RHS)

Source: Company, ICICIdirect.com Research

Return on assets consistently above 1%

HDFC Bank has been maintaining return on assets around 1.3-1.4% for the past three years. However, because of the merger with CBoP we have seen the RoA coming down to 1.2% for FY09. However, as synergies creep into the system, we believe it will again pick up to 1.4% for FY10E and improve further to 1.5% in FY11E. Exhibit 30: RoA: To pick up post FY09E
2 1.5

1.5

1.4

1.3

1.3

1.4 1.2

(%)

Because of merger of CBoP

0.5

Once Synergies creep in by shoring up branches

0 FY06 FY07 FY08 FY09 FY10E FY11E

Source: Company, ICICIdirect.com Research

(%)

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Valuations
HDFC Bank has been historically registering a growth of more than 30% in its bottomline. The bank has been maintaining higher than industry average NIMs (reported) at above 4%. The major reason is a well-diversified loan book coupled with the ability to maintain and sustain higher than average CASA deposits (near 50%). Also, with adequate multiple distribution channels and effective cross selling of products the bank has been able to gain traction on the fee income side. These factors, along with its able management have enabled the bank to command a premium multiple, as it has always traded at 3x-3.5x on a rolling one-year forward P/ABV multiple. At the CMP of Rs 1366, the bank is trading at 3.1x and 2.9x its FY10E and FY11E ABV, respectively. We expect HDFC Bank to be able to generate RoEs in the range of 15-16% over the next two years. After considering three possible scenarios of capital raising via warrants conversion (Exhibits 31-33), we value the bank at a conversion price of Rs1510. Thereby, we have arrived at FY11E fair ABV of Rs 478. We value the stock at 3.0x FY11E ABV to arrive at a target price of Rs 1434. We recommend HOLD on the stock Alternative scenario I Exhibit 31: If conversion of warrants takes place @ Rs 1520 as stipulated
Basic EPS Diluted EPS Book value per share Normal ABVPS P/PPP P/E P/BV P/ABV DPS FY2008 44.9 44.9 324.4 316.0 13.2 31.2 4.3 4.4 8.0 FY2009 52.9 52.9 351.1 327.3 11.5 26.5 4.0 4.3 12.6 FY2010E 62.3 62.3 467.2 438.6 9.5 22.5 3.0 3.2 13.0 FY2011E 77.6 77.6 509.1 478.7 8.0 18.0 2.7 2.9 16.2

Source: Company, ICICIdirect.com Research

Alternative scenario II Exhibit 32: If conversion of warrants takes place @ Rs 1100/share instead of Rs 1520
Basic EPS Diluted EPS Book value per share Normal ABVPS P/PPP P/E P/BV P/ABV DPS FY2008 44.9 44.9 324.4 316.0 12.9 30.5 4.2 4.3 8.0 FY2009 52.9 52.9 351.1 327.3 11.2 25.9 3.9 4.2 12.6 FY2010E 62.3 62.3 442.2 413.6 9.3 22.0 3.1 3.3 13.0 FY2011E 77.6 77.6 484.1 453.7 7.8 17.7 2.8 3.0 16.2

Source: Company, ICICIdirect.com Research

Our drawing of the alternative scenarios I, II and III hinges on the weak capital markets that may lead to either the lapse of conversion warrants or a repricing of the same.

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Alternative scenario III Exhibit 33: If HDFC denies conversion of warrants in FY10E
Basic EPS Diluted EPS Book value per share Normal ABVPS P/PPP P/E P/BV P/ABV DPS FY2008 44.9 44.9 324.4 316.0 12.9 30.5 4.2 4.3 8.0 FY2009 52.9 52.9 351.1 327.3 11.2 25.9 3.9 4.2 12.6 FY2010E 66.2 66.2 401.4 371.0 8.8 20.7 3.4 3.7 13.8 FY2011E 82.4 82.4 445.9 413.7 7.4 16.6 3.1 3.3 17.2

Source: Company, ICICIdirect.com Research

Exhibit 34: Peer set comparison

P/E (x) 25.9 14.9 12.8 5.6 FY09 P/ABV (x) 4.2 2.7 2.4 1.5 ROE(%) 10.5 19.1 20.7 24.5 P/E (x) 22.0 12.9 10.3 5.1 FY10E P/ABV (x) 3.1 2.4 1.9 1.2 ROE(%) 15.6 18.9 20.3 22.3 P/E (x) 17.7 10.9 8.6 4.4 FY11E P/ABV (x) 2.9 2.0 1.6 1.0 ROE(%) 15.9 19.1 20.4 21.4

HDFC Bank Axis Bank Yes Bank BOI

Source: ICICIdirect.com Research

Exhibit 35: RoE decomposition

(%) Net interest income/ Avg. assets Non-interest income/ Avg. assets Net total income/ Avg. assets Operating expenses/ Avg. assets Operating profit/ Avg. assets Provisions/ Avg. assets Return on Avg. assets Leverage (Avg assets/ Avg equity) (x) Return on equity
Source: ICICIdirect.com Research

FY08 4.7 2.0 6.7 3.3 3.4 1.3 1.4 12.5 17.7

FY09 4.3 1.7 6.0 3.5 2.5 1.2 1.3 12.0 17.0

FY10E 4.6 1.9 6.5 3.2 3.4 1.3 1.4 12.4 17.6

FY11E 4.5 1.9 6.4 3.0 3.4 1.2 1.5 12.8 19.4

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Exhibit 36: Financial performance

Profit and Loss Account Interest Earned Interest Expended Net Interest Income Growth (%) Non Interest Income Net Income Employee cost Other operating Exp. Operating Income Provisions PBT Taxes Net Profit Growth (%) Balance Sheet FY08 Liabilities Capital Reserves and Surplus Networth Deposits Borrowings Subordinated Debt Other Liabilities & Provisions Total Assets Fixed Assets Investments Advances Other Assets Cash with RBI & call money Total 354 11143 11497 100769 4479 3249 13183 133177 FY09 425 14486 14911 142736 6885 5227 13769 183527 FY10E 425 16621 17045 168228 5990 5427 15145 211835 FY08 10115.0 4887.1 5227.9 50.7 2283.2 7511.0 1301.4 2444.3 3765.4 1484.8 2280.6 690.5 1590.2 39.3 FY09 16332.3 8911.1 7421.2 42.0 3290.6 10711.8 2055.6 3477.2 5179.0 1879.7 3299.3 1054.3 2245.0 41.2 FY10E 18001.2 8927.3 9073.9 22.3 3796.7 12870.6 2480.7 3751.3 6638.6 2537.7 4100.9 1291.8 2809.1 25.1 Rs. Crore FY11E 20496.0 10080.2 10415.8 14.8 4392.5 14808.3 2721.4 4201.7 7885.3 2780.2 5105.1 1608.1 3497.0 24.5 Rs. Crore FY11E 425 18509 18934 202282 6238 5927 16659 250040

1175 49394 63427 4403 14778 133177

1558 65661 100256 3031 13022 183527

1714 76481 119916 1532 12192 211835

1751 85116 145757 3076 14340 250040

Source: Company, ICICIdirect.com Research

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Exhibit 37: Ratios

FY08 Valuation No. of Equity Shares EPS (Rs.) BV (Rs.) BV-ADJ (Rs.) P/E P/BV P/adj.BV Div. Yield (%) DPS (Rs.) Yields & Margins (%) Yield on avg int earning assets Avg. cost on funds Net Interest Margins (calculated) Avg. Cost of Deposits Yield on average advances Profitabilty (%) Interest expense / total avg. assets Interest income/ total avg. assets Non-interest income/ avg. assets Non-interest income/ Net income Net-interest income/ Net income Cost / Total net income Quality and Efficiency Credit/Deposit ratio GNPA (%) NNPA (%) RONW (%) ROA (%)
Source: Company, ICICIdirect.com Research

FY09 42.5 52.9 351.1 327.3 25.9 3.9 4.2 0.9 12.6

FY10E 42.5 66.2 401.4 371.0 20.7 3.4 3.7 1.0 13.8

FY11E 42.5 82.4 445.9 413.7 16.6 3.1 3.3 1.3 17.2

35.4 44.9 324.4 316.0 30.5 4.2 4.3 0.6 8.0

9.5 5.3 4.9 5.2 12.6

9.8 5.9 4.4 5.7 12.3

9.3 5.3 4.7 5.2 11.8

9.1 5.1 4.6 5.0 11.3

4.4 9.0 2.0 30.4 69.6 49.9

5.6 10.3 1.7 30.7 69.3 55.1

4.5 9.1 1.9 29.5 70.5 48.4

4.4 8.9 1.9 29.7 70.3 46.8

62.9 1.4 0.5 17.7 1.4

70.2 2.4 1.0 17.0 1.3

71.3 2.7 1.1 17.6 1.4

72.1 2.5 0.9 19.4 1.5

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Glossary
Cash reserve ratio (CRR): Every scheduled commercial bank was required to maintain with the RBI every fortnight a minimum average daily cash reserve equivalent of 5% of its net demand and time liabilities (NDTL) outstanding as on the Friday of the previous week. Current account savings account (CASA): It is the proportion of current account and savings account deposits in total deposits. Net interest margin (NIM) It is the ratio of banks net interest income to its interest earning assets. It basically depicts banks net interest earning capability from the assets deployed. Held-to-Maturity (HTM) Investments that the bank intends to hold till maturity. Available for Sale (AFS) - Investments that are available for sale anytime after 90 days from the date of purchase. Capital Adequacy Ratio (CAR) Capital adequacy is determined as a ratio of capital funds to total risk weighted assets of the bank. Currently, the minimum CAR to be maintained is 9%. Non-performing assets (NPA) These are advances where the principal and interest is not paid by borrower for 90 days. Net NPA = Gross NPA Provisions CAGR Compounded annual growth rate Net interest income (NII) Total interest income less total interest expense Adjusted book value (ABV) Book value per share less NNPA Dividend per share (DPS) Dividend declared pr share

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RATING RATIONALE

ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Outperformer, Performer, Hold, and Underperformer. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Outperformer (OP): 20% or more; Performer (P): Between 10% and 20%; Hold (H): +10% return; Underperformer (U): -10% or more; Pankaj Pandey Head Research ICICIdirect.com Research Desk, ICICI Securities Limited, Gr. Floor, Mafatlal House, 163, HT Parekh Marg, Backbay Reclamation Churchgate, Mumbai 400 020 research@icicidirect.com ANALYST CERTIFICATION
We /I, Kajal Jain CA Chirag Shah PGDBM (Finance) Viraj Gandhi MBA (CM) research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

pankaj.pandey@icicidirect.com

Disclosures:
ICICI Securities Limited (ICICI Securities) and its affiliates are a full-service, integrated investment banking, investment management and brokerage and financing group. We along with affiliates are leading underwriter of securities and participate in virtually all securities trading markets in India. We and our affiliates have investment banking and other business relationship with a significant percentage of companies covered by our Investment Research Department. Our research professionals provide important input into our investment banking and other business selection processes. ICICI Securities generally prohibits its analysts, persons reporting to analysts and their dependent family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. 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Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. The recipient should independently evaluate the investment risks. The value and return of investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to see Risk Disclosure Document to understand the risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to change without notice. ICICI Securities and its affiliates might have managed or co-managed a public offering for the subject company in the preceding twelve months. ICICI Securities and affiliates might have received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. ICICI Securities and affiliates expect to receive compensation from the companies mentioned in the report within a period of three months following the date of publication of the research report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. It is confirmed that Chirag J Shah, PGDBM; Kajal Jain, CA, Viraj Gandhi (MBA CM) research analysts and the authors of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Our research professionals are paid in part based on the profitability of ICICI Securities, which include earnings from Investment Banking and other business. ICICI Securities or its subsidiaries collectively do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. 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