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.

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.

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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.

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.

Know. Think. Then Invest.

Aam aadmi is always busy in trying to meet his ends. Whether business or employment, people are looking for ways that lead to financial freedom. Children, house, retirement, health, lifestyle are some of the requirements which haunt a typical household everyday when they hear about a price hike. Most of the life of an individual is spent in catering to the ROTI, KAPDA & MAKAAN for his family. This is irrespective of the fact that the requirements get satisfied very soon but the wants keep on increasing with every accomplishment.

Now to fulfill the needs & satiate the desires, a person works. He gets salary or profits. He uses this money to buy necessities and luxuries. He is not satisfied. He wants more money. Not only for this time but future also. Future requires us to save money. So we have bank accounts. But value of a thing/facility now will not remain same in future. Hence we need not just our savings but a return over these. This introduces a world of financial products.

There is an important thing to understand. People look at their peers, watch advertisements, read articles and hear discussions, and take investment decisions. No two patients are same for a doctor and each patient needs a specific treatment for same illness, each investor is also unique in terms of his risk profile and return expectations. Before investing a rupee in the market, one should ask himself, do I understand what it means to invest in this particular security. People can judge promises like doubling the money, right product for you, we are the experts, etc. only when they understand what's behind them. I may not want to double my money but a descent return, just over inflation, but preserve my investment as I see my brother going to college next year.

Broadly for a common man, debt and equity products fill asset classes. Each of these classes has numerous products for people with different risk and return profiles. But do we as investors analyse which product suits me? No. And this is what brings windfall gains to one and suicidal situation for other.

Debt Products - These are saving plans where the risk is low. For a common man, risk should mean probability of loss of investment. If you put Rs. 100 in a product, how much are the chances that you will face a reduction in your investment i.e. Rs. 100. This is important. Ignorance can be no excuse here. When we go outside the world of traditional and nearly risk-free investments, like bank & post office saving facilities (FD, RD, NSC, PPF, etc.), we are entering a world of uncertainty. Understanding of this very concept makes life of people hell or heaven. Repetition of sentences is intentional here owing to their importance. Debt investments can be suitable for people who have safety of investment as their short term goal and a descent return over traditional products in the long term. Short term can be construed as six months to one year. Descent return can be something greater than 2%. So if you see a requirement of your cash in the coming next quarter, stay attached to FDs or savings account. If your requirement extends to about a year, debt mutual funds (liquid & short term) can be suitable. Pl note to Know. Think. Then Invest.

Equity Products - Equity is becoming part of portfolio of everyone these days, even for those in tier-3 cities. This is what is going wrong. People are playing with petrol without trying to know that it is highly combustible. Whose fault will it be if someone catches fire. One would say - "What a fool!". Another example can be shopping. If you buy the same gadget for Rs. 100 more than what your friend paid, you feel cheated. But the market will say, he did n't do enough research. What then can be said for our dear investor. Equity is most rewarding in the long term. This is the most common statement in investment prospectuses and textbooks and no one can deny the fact. Equities are wealth generating machines, if used appropriately. Else make life hell. People have put their life savings, daughter's dowry, mortgaged their properties and put money in equity to make a fortune. Reliance Power IPO was such one case. Equities have very varying returns and so is the most risky investment option.

Then should we not invest in equities? No. Idea is to understand. Equities are based on price of shares which depend on the market. If market is in good mood, you are rewarded. So now two important consideration points for investors arise. One for how long to invest. Second, which companies/mutual funds to invest in. "how long" can be said to be more than 2 or 3 years. This duration is not anchored. But an investor should be ready to be without his investment for such a time horizon, else if markets are unhappy, he may have to liquidate at a loss. For the part of which companies/funds to invest in, if you find it hard to understand growth, sectors, valuation, etc. please go for front-end companies like TATAs, RELIANCEs, MAHINDRAs, top banks, etc. These and such companies with credible management (we read interviews, comments of their promoters in all newspapers) and best of brands (whether cars, electronics, banks, power, etc.) which are famous India-wide. The speculation here is that such companies shall show descent growth and a low risk of loss of investment over our time horizon (discussed above). Small caps, mid caps, growth companies, next this and next that are terms useful for those who can evaluate the variables on which these phrases are based. Mutual funds are an even less riskier option. There are many websites which provide rating to mutual funds. Informed decision should be to cross check the ratings, performance of funds over relevant period and check for the consistency of returns. A one time star performer can be risky. Looking for top five performers over past 3-5 years can help us in shortlisting useful players.

Investing can make you rich. How? When? These are the questions that you have to understand. Never losing your money is what "father of modern investing" Warren Buffett preaches. Therefore, know (risk and return), think (how your risk profile affects the choice of investments, and what should be, thus, your return expectation) and invest (put your hard-earned money and reap returns).

Measuring Sector Performance

Periodically investment managers and investors take a stock of performance of various sectors. Objective is to find out which sector(s) have been the best performers (those which provided returns i.e. increased in value, above what the market did) and worst performers.

A convenient way of measuring performance of a particular sector could be using the sectoral indices provided by NSE or BSE. I have used NSE indices for the analysis. For gauging market performance, one can look at the broad market index like NIFTY.

This analysis tells us how much each sector has risen/fallen vis-à-vis the market. Then, a fund manager digs into the facts that why a particular sector outperformed/underperformed the market. Was it because of the fundamentals or bullish/bearish opinion of the investors? In the first case, fund manager may accept the respective rise/fall in the sector. However, in second case, the fund manager can see an opportunity to invest in companies in underperformed sectors and liquidate companies in outperformed sectors.

Following graph depicts the performance of various sectoral indices maintained by NSE. The graph shows performance from 01-Sep-08 to 18-Sep-09.

Let us now try to figure out the performance of various sectors.
The above graph tells us that Realty has been the worst hit sector despite the ongoing rally. The reasons could be bleak demand, pressure of borrowings, and still not-so-positive consumer confidence due to poor job market.

Banking sector has been a sure-shot winner with PSU banks enjoying a whopping rise of 51% and overall index of banks witnessing a performance of 37%. This could be attributable to the unjustified/excessive thrashing which these banks bore when everyday a US bank was going burst. With no such case being witnessed in India, investors have reposited their confidence back. Also, the expectation of rising of policy rates like CRR, repo rate, etc. in future, from their 10-year lows, can be looked at as an indicator of better results in banking and financing sector.

The fall of IT sector during 2008 was taken by some investors as justified with the view that recessionary business conditions in US and other developed countries will lead to diminished outsourcing business of Indian IT companies. Again, the fall was felt unjustified by some investors who grabbed the opportunity and did value-investing. Hence we observe a return of 27% in just over a year.

Infra has been one of the most talked about sectors in India, especially in the past two years. Reasons could be – Commonwealth Games 2010, widespread unemployment due to diminished business activities in slowdown, poor-to-late monsoon, agenda of the once-again elected Congress government, China’s drive in infra development, etc. Companies included in this index are - ABB, BHEL, Bharti, DLF, GMR, IVRCL, Idea, Indian Hotels Co. Ltd., Jaiprakash, Jet Airways, L&T., MTNL, NTPC, Reliance Communications, Reliance Infrastructure, Reliance Power, Siemens, Suzlon, Tata Communications, Tata Power, Unitech.

A periodic analysis of sectors helps us in finding out which sectors were given a treat by the market and which were hit badly. For a value investor, this is fishing time as it might be that some stocks in the second case fell unnecessarily. Such stocks can provide opportunity to earn above market return in a small duration. But now we are talking only on base of fundamentals. So be careful.