We came across a bullish thesis on HDFC Bank Ltd (HDB) on ValueInvestorsClub by Par03. In this article we will summarize the bulls’ thesis on HDB. HDFC Bank shares were trading at $59.02 when this thesis was published, vs. closing price of $61.00 on Aug 29.
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HDFC Bank, the largest private sector bank in India, has built a formidable reputation over the years. With an 11% market share of deposits, it is a cornerstone of the Indian banking sector. The bank’s success is underpinned by its comprehensive range of banking services, including retail banking, wholesale banking, and treasury operations. Its retail banking division, which covers a wide array of services from savings accounts to loans, is particularly significant, as it taps into India’s vast and growing middle-class market. HDFC Bank also benefits from its robust credit card business, which is one of the largest in the country. Additionally, the bank’s wholesale banking segment caters to large corporations, providing them with a suite of financial services. This combination of diverse revenue streams, coupled with the bank’s deep penetration into both urban and rural markets, solidifies HDFC Bank’s position as a leader in its industry.
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Despite its strengths, HDFC Bank’s stock has underperformed recently, driven primarily by concerns surrounding its merger with Housing Development Finance Company (HDFC Ltd). The merger, which was completed in July 2023, initially received positive market reactions. The logic was sound—HDFC Ltd, one of India’s largest mortgage lenders, would benefit from HDFC Bank’s cheaper deposit funding, while HDFC Bank could cross-sell banking services to HDFC Ltd’s customer base. However, after the merger, management disclosed that the deal, contrary to expectations, would be dilutive to both book value per share and earnings per share in the short term. This was largely due to accounting adjustments and a decision by HDFC Bank to increase loan loss allowances for the acquired entity. Additionally, the bank warned of temporarily lower profitability as it integrated the merger, with return on assets expected to dip from the historical 1.9-2.0% to around 1.8% in FY 2024.
Adding to investor concerns, HDFC Bank’s December quarter earnings for 2023 disappointed, primarily due to sluggish deposit growth, which led to a higher loan-to-deposit ratio. This raised fears that the anticipated benefits of the merger, particularly the replacement of HDFC Ltd’s high-cost wholesale funding with low-cost deposits, might take longer to materialize. However, HDFC Bank’s management has reassured investors that these challenges are temporary, linked to the integration process.
Despite these merger-related hurdles, HDFC Bank remains a strong contender in India’s banking sector. The bank operates in a relatively underbanked market where there is ample room for growth, unlike more saturated banking markets like the U.S. or Europe. Moreover, HDFC Bank has a superior corporate culture, particularly in managing credit risk, which has allowed it to consistently deliver strong returns on equity (ROE) and grow earnings per share (EPS) at a double-digit rate over the years.
Recently, there have been signs of improvement. In March 2024, HDFC Bank disclosed strong deposit growth, with an encouraging mix that favored low-cost checking and savings accounts. This has already started to bring down the loan-to-deposit ratio, suggesting that the bank is on the path to resolving its merger-related issues. Trading at historically low price-to-book multiples, HDFC Bank’s current valuation could offer a compelling entry point for investors willing to bet on the bank’s ability to navigate these temporary challenges and return to its growth trajectory.
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Disclosure: None. This article is originally published at Insider Monkey.
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