HDFC Bank Ltd: Analysis

Background: HDFC Bank Ltd (NSE: HDFCBANK; BSE: 500180) is the largest private sector bank in terms of advances as well as deposits. The bank has presence in both segments viz. wholesale segment (commercial and transactional banking) and retail (branch banking) offering all major products business loans, vehicle loans, personal loans as well as credit cards. It was identified as Domestic Systemically Important Bank (apart from SBI & ICICI) by RBI in 2017.

Strong player in banking space: Not only the bank boasts of its strong market position with balance sheet of INR 16.54 lac cr (as on December 31, 2020), it is well-diversified with 48:52 mix of retail and wholesale loans. Loan book at the end of Q3FY21 (refers to period from April 01 to December 31) has growth consistently over the years and stood at INR 10.82 lac cr with low NPAs of INR 1.38%, showing high quality of the loan book. Nevertheless, the bank is adequately capitalized for any unforeseen losses with Capital Adequacy Ratio (CAR) and Tier-I CAR were 18.9% & 17.5% respectively.

Robust and consistent growth in loan book: The Bank has been aggressive in its expansion strategy with shifting focus on corporate segment where disbursements had actually dried up since ILFS fiasco in 2018. The total loans grew by 24% in FY19 and 21% in FY20; stood at INR 10.82 lac cr as on Dec 31, 2020, clocking YoY growth of 15.6%. As seen in below chart, the growth is largely backed by strong rise in wholesale loans (consistently more than retail).

The bank has been a strong player in the corporate segment with more than 20% growth in last three fiscals. However, the growth has not been at the cost of asset quality. The bank’s barometer to measure that i.e. average internal rating stood at 4.4 (scale of 1-10) for the corporate book as on Dec 31, 2020 which is equivalent to ‘AA’ rating by credit rating agencies.

Disbursements for the retail segment during the quarter had crossed pre-Covid levels with 20% yoy growth, meaning that the business is gaining traction for micro/small businesses. The bank’s retail book has mainly constituted of personal, auto & home loans. Interestingly, comparing the bank retail book from Mar-2020 to Dec-2020, it can be noticed that auto loans have been cut by 3.5% while home loans have grown by 5%. This further boosts the quality of loan book as houses fare better collaterals than vehicles.

Over the years, the bank has been focusing on augmenting the corporate loan book and the efforts have yielded results. The loan mix which was skewed towards retail book is now balanced.

Income: The bank has reported consistent growth in income figures during last 10 years. In fact, it has achieved at whopping 22% CAGR in operating revenue during 2010-20. In Q3FY21, the bank saw growth 15.1% growth in Net Interest Income (NII). It is difference between interest earned on loans & interest paid on borrowings/deposts; the two most important figures impacting profitability of a bank. Bank’s Net Interest Margin (NIM), measures how much spread a bank makes on a rupee lend, has remained stable at 4.2%. 

Apart from interest, a bank also earns fee-based income from writing loans, distributing 3rd party products (like insurance), commissions, treasury gains, income from investments, etc.

Deposits: These are one of the cheapest sources of money for the bank; classified into current, saving and time deposits. Of these current and savings account (commonly known as CASA) balances are most crucial for a bank as these come at lowest costs. So for a bank, higher the CASA, the lower is cost of funding. HDFC Bank has been able to maintain its CASA at 42-43% consistently. CASA grew at 30% in Q3FY21; highest in last 5 quarters.

Adequate capitalization: RBI stipulates a minimum capitalization which all banks have to maintain to provide for in case of any unforeseen increase in bad loans. Capital Adequacy Ratio measures this which is ratio of capital to risk weighted assets. Against requirement of 11.075%, bank’s CAR stood at 19.1%. Bank’s CAR for Tier-1 capital was 17% (minimum requirement: 7.575%). Being identified as a Domestic Systemically Important Bank (D-SIB), it has to maintain additional 0.20% CAR.

Robust book quality: Growth in business is tough, quality growth in even more. And the best parameter to evaluate a bank’s book quality is NPA. The bank has been able to manage the GNPA% (of advances) at less than 1.4% and NNPA% at 0.4% levels during FY18-20. In Q3FY21, the GNPA% reduced noticeably to 0.8% and NNPA% to 0.1%. Compare this with GNPA% of HDFC Bank’s peers such as SBI 4.77%, ICICI Bank at 4.38%, Axis Bank at 3.44%. Though, the low figures for Q3 were also owing to directive by Honorable Supreme Court that those accounts that had not been declared NPA till August 31, 2020 should not be declared as NPA until further orders. However, the bank has been monitoring the actual NPA levels as per their assessment model, the GNPA% (proforma) will be 1.37%.

The bank is an ideal stock in one’s portfolio with professional management team, jaw-dropping income growth, balanced segmental loan book, lowest NPA levels and huge size.

Auto sector- Wounded but still resilient

The importance of the automobile sector, comprising of Original Equipment Manufacturer (OEM) and their auto-component suppliers, can’t be stressed enough. It is one of the largest employers in the manufacturing sector due to forward and backward linkages with other key industries, contributes more than 7% to GDP and projected to be world's 3rd largest automotive market in terms of volume by 2026.

However, the sector has got little attention despite the rough patch it has been going through. Post IL&FS fiasco, the funding for the sector, like most of other sectors, had dried up, interest rates were high, volumes dipped, metal costs squeezed margins, capex incurred on capacity augmentation wasn’t giving returns (due to low volumes), fixed costs kept rising (added by capex), Government regulations on emissions and applicability of BS-VI, promoters were hesitant to put in their money and so on. The list doesn’t end, neither the miseries of players in this sector.

FY20 itself was a bad year for the sector. One can’t talk enough about what this industry has gone through during the Covid-19 pandemic but even before that i.e. Q1, Q2 and Q3 saw decline in sales volume. Sales volume in 9MFY20 (period from April 01 to December 31) for the entire sector had gone down by 24% (Auto Industry Sales Performance of December & April-December 2020) largely dragged by 3-Wheeler (3W) and Commercial Vehicle (CV) segment.

Things got worse in Q4 FY20, especially from March 2020 when Covid-19 pandemic had started impacting entire world. Nobody had thought that after the torture our automobile industry had gone through in FY20, there was a new hell waiting for it viz. ‘Pandemic Covid-19’. It had killed millions globally, practically stopped the whole world, house-arrested people, thrown millions out of jobs and what not. Prior to Covid-19 spreading worldwide, industry was expecting growth from April 2020 onwards. However, all such hopes shelved later. Plants were under shut-down, salaries had to be paid as government had imposed notification for no firing or cut in salaries, fixed plant expenses stayed but collections had dried-up. 

Though GoI announced first lockdown on March 24, 2020 (4th week) for 21 days, the damage to the sector was already done. Consequently, the industry’s sales witnessed a fall of 45% in March alone. CV sales plunged by 88% due to muted performance of infrastructure & construction sectors, PV by 51% given the decline in spending by households and uncertainty about future growth; 3W and Two-Wheeler (2W) were also down by 58% and 40% respectively owing to lackluster rural demand. It was bloodbath for the sector which was already shy of poor show during the year.

For FY20, PV sales declined by 18%, CV by 29%, 3W and 2W by 9% and 18% respectively. Overall impact was depressing 18% to the sector. One can’t be empathetic enough for what it means for the companies, their vendors, employees and the economy as a whole. 

Market leader Maruti Suzuki India Ltd’s (MSIL) sales volume witnessed degrowth of 18%, Hero Motocorp Ltd (HMCL) of 18%, Mahindra & Mahindra (M&M) 18%, Bajaj Auto Ltd (BAL) 8% and Tata Motors Ltd (TML) 18%. Analysis of the financial performance requires a separate article which we shall come up soon. Right now, let’s just focus on sectoral results.

Just to understand the impact on the sector, auto sales dropped by 75% in Q1; PV by 78%, CV by 85%, 3W by 91% and 2W by 74%. It takes years to see growth of such quantum which just got vanished in a quarter which had 45 days lockdown. The chart just shows these figures.

However, one could see the silver lining from June onwards when lockdown was being enforced in specific areas only, factories had resumed operations, supply-chain was getting back on track, people were going for buying essentials, etc. The resilience of Indian economy and auto industry made the early comeback possible for the players. Rural India was lesser impacted by the pandemic and also first to get back on track. That, along with declining impact of pandemic, good monsoons, approaching festive season, Q2 saw growth of staggering 17% in PV sales volumes while 2W was largely at previous year levels. CV and 3W still struggled due to lack of traction on infra projects as well as inter & intra state supply-chain issues.

But what about Q3? This is the most promising part of year for the whole economy, especially for automobile sector, with Diwali and Dhanteras stealing most sales. Price hike by OEMs in the New Year was another factor impacting auto sales in Q3. Sales for PV grew yoy by 14% and 2W by 13%, while CV was largely at previous year levels with just 1% dip in sales. 3W sales kept plummeting at 59% in Q3.

Starting the New Year 2021 with fingers crossed and hope in eyes, we saw many OEMs revising vehicle prices. This was to enable them tide over (a) losses incurred during 9MFY21 and (b) increase in commodity prices, especially steel and copper. The green shoots can be seen with overall vehicle sales increasing by 5% yoy and 24% MoM in January 2021. PV segment enjoyed jump in sales of 11% YoY backed by 37% growth in UV while car sales fell by 1% YoY. 2W sales grew by 7%. CV data was not available with SIAM (actually SIAM has stopped sharing monthly CV data since past few months due to unavailability of data from some OEMs).

While there have been countless challenges in the automobile sector. However, the industry has, with its resilient performance, shown that it remains a crucial contributor to nation’s growth and has all that is needed to sail through anything adverse.

Data/Sources:
• SIAM Press Releases
• ET Auto News

Analysing Banking Stocks

Banks are institutions which are part of our daily lives. We have been witnessing growth in the size of the industry (many new players have entered in the past 10 years) and quality of services (more branches, better cust0mer dealings, internet banking & plastic money, improved loan and deposit products). In a sense, we have known how the industry has moved from a typical sarkari sector to a globally competitive playfield.

In this article, let us just look a bit deeper to how banking sector can be used for investment, by way of stocks.  Many schedules banks are listed in India which makes it easier for us to compare their performance and know about the industry features. To begin with the analysis, it is convenient to understand the income & expenditure concepts and key ratios of banks.

CASA (Current Account Savings Account): People & institutions place money (Deposit) with a bank for a certain period and/or earn interest/avail services. Deposits can be Demand Deposits, Savings Bank Deposit & Term Deposit. Out of the total deposits that customers have kept with the bank, savings accounts cost just 3.5% to and current accounts are charged to the customers for services provided by the bank, whereas the term deposits (FD, RD, etc.) cost higher. Funds from any type of deposit are lent by bank at much higher rate. Therefore, the bank which has higher proportion of savings & current accounts money out of the total deposits is in a more profitable position from the one whose deposits consist more of term deposits. Industry measures this feature of a bank as CASA Ratio i.e. amount of savings and current accounts as a percentage of total deposits held with the bank.

NPAs (Non-Performing Assets): Banks lend to earn interest. Lending by banks is governed by regulations of RBI & its own lending policy mainly. Banks are required to do thorough due diligence before accepting the lending proposal. NPAs are such advances of a bank which have ceased to provide income to the bank. RBI stipulates a period of 90 days for identification of NPAs. NPAs could either become good entirely or partially or may result in 100% loss to the bank. Provisions are created as per RBI guidelines for NPAs. The lower the quantum of NPAs, the better.

NIM (Net Interest Margin): This is the ratio of net interest earned (Interest earned – Interest paid) by the bank as a % of interest-earning assets i.e. advances. The ratio helps us in assessing the efficiency of the bank. More NIM, better.

----------------

Many other ratios like ROI, ROA, ROE, operating margins, etc. can’t be ignored.

Honestly, I haven’t seen banks moving up and down according to their fundamentals. Also there is no guarantee that stocks bought based on such analysis will yield green figures in your portfolio statement.  But when we are in the market to buy shares without exactly knowing which stocks will be profitable, isn’t better to buy shares with strong fundamentals. SBI being the largest bank of India by assets. This feature of SBI is enough to make it a strong stock. Now even if an investor is having a long position in SBI at a price much higher than the prevailing market price, he can be reasonable assured that he has his money in a safe bet.

Graham on investing

The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. While small companies may also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.

Value Investing

Markets have been like weather in Delhi. Sometimes rising more than 100 points in a day (becoming hot) and falling by a similar score the next day (chiller). Correction of about 9% in Nifty and more than 15-30% in most blue-chip stocks.

As an investor, there are two most important things to think - where will the markets move and how will the stocks in portfolio behave. The first part is something which an investor is not much worried about as he takes investment decision based on facts and not predictions alone. Predicting the market behavious is not only dicey but can be a costly affair as even though our prediction, about market and stocks, is correct but when will the market reflect that prediction into prices is also unknown.

Value investing has been defined by countless investors and academicians. For me, what little I know about investing, VALUE INVESTING is investing in stocks that provide enough evidence of the value that an investor finds has been ignored by the market. As one might comment, it is easier to define than to practice. Being a investor with very modest investments and understanding, still I find that when the decades old rules are applied to investing, it can fetch descent returns (more than a FD) with lower risk. But value investing does not at all mean investing in all low P/E, low P/BV stocks or those stocks which have fallen by 50% or more during the year.

Important for us to understand is that markets can misprice stocks despite existence of FIIs, IIs, DIIs, analysts, etc. And the most common reason which I see for such mispricing is that so many people are analysing stocks with borrowed beliefs. If the financial TV channels and reports say that infra sector shall not do well, then majority of us buy such analysis. Result is that the stocks get the beating much more than what is deserved. Similar happend with IRB (went down to 158; already recovered by 17%), JP Associates (72.35; 16%), L&T (1487; 8%). People said so about Banking and NBFC sector also with outlook of tight liquidity and rising cost of borrowing. Kotak Mahindra Bank (339; 20%) IDFC (123; 10%). Now it is very easy and comforting in the hindsight to find out such stocks which got a market thrashing and recovered. It is easier to show astronomical returns by using their lowest price during the period of analysis. However, one can agree that such stocks are fundamentally good businesses with able management and a strong track record of performance. Even though, such stocks in similar businesses did not yield much till now but an investor can be assured of their recovering in the next 3-12 months.

Not complicating the concept, Value investing for me is to look for great (in terms of size, history) business and attractive price, price which one without going into valuation model finds too low for the Company. Maybe because of the peer comparision or due to stock's own historical prices. Using the 52 week low price or P/E or P/BV can be a helper.

Still the probability of suffering losses can't be eliminated but idea is to minimize the probability of losses.

Using nifty sparks, one can easily find stocks that are down in the past 30 days and a comparision with their 365 days prices is also provided. Another benefit of using sparks is that the stocks shown are included in indices which assures liquidity of stocks.