HDFC Bank witnessed a substantial drop of over 12% in a massive sell-off over the weekend, which was attributed to HDFC Bank’s December quarter earnings, which revealed a combination of flat net interest margin (NIM) and slower deposit growth on a sequential basis. Additionally, provisioning for alternate investment fund (AIF) investment weighed on the stock price.
Of particular concern for the market is the bank’s return on assets (RoA), a measure of how efficiently a company uses its assets to generate profits, slipping below 2%. This departure from the historical RoA of 2% and above has raised apprehensions among value investors.
Foreign institutional investors hold a higher percentage of HDFC Bank compared to peers such as ICICI Bank and Kotak Mahindra Bank but slightly lower than Axis Bank.
Following the HDFC Bank-HDFC merger in July, the bank has entered the top 10 global lenders by market capitalization. Consequently, the bank’s performance is now being compared to global peers like JP Morgan. Any indication of a growth slowdown or pressure on key ratios, such as RoA or NIM, is expected to impact shares, analysts have noted.
Growth challenge
Brokerages estimate that HDFC Bank’s RoA is likely to remain below 2% for the coming financial years, mainly reflecting expected pressure on NIM. The bank’s historically premium valuation, supported by consistent growth backed by a retail franchise, is facing challenges post-merger, and investors are closely monitoring its deposit mobilisation efforts.
While there are opportunities for growth, such as offering home loans directly to the bank’s customers, growing on an expanded balance sheet is challenging. Deposit mobilization has been a hurdle for most banks, and HDFC Bank’s deposit growth in the December quarter lagged behind loan growth.
Moving forward, the spotlight will be on the bank’s ability to garner deposits, directly impacting its profitability. The net interest margin (NIM) stood at 3.5% in Q3, a notable deviation from the historical bandwidth of 4 – 4.2%. The bank faces decisions on potentially hiking deposit rates to attract more inflows and prioritizing bulk deposits over retail deposits to maintain a robust deposit engine. Both options entail downside risks to the bank’s financials.
The recent sluggish performance, combined with concerns about NIM and deposit growth, has led to a reevaluation of HDFC Bank’s stock. Investors are cautious about factors such as branch additions falling short of expectations and slower growth in low-cost current account, savings account (CASA) deposits. The bank’s high valuation, coupled with these concerns, has led to a reassessment of its attractiveness as an investment.
Despite the challenges, some brokerages, such as Elara Capital, recommend accumulating the stock, citing potential for growth and a target price of Rs 1,889, indicating an upside of 27% over Thursday’s closing. However, the current fall in the stock price raises questions about its status as a reliable and consistent return generator, a reputation it has held for years.
Growth outlook
While the management remains optimistic about growth, market observers caution against expectations of the remarkable 20% plus growth rate seen in recent years. In Q3, the net interest income grew by 24% year-on-year to Rs 28,470 crore, adjusted for HDFC Ltd’s base effect. However, excluding the impact from home loans, the overall loan growth in Q3 appeared uninspiring.
Segments such as auto loans, credit cards, and personal loans – considered the bank’s stronghold – experienced growth at sub-18% rates. Notably, personal loans, affected by RBI’s recent circular on risk-weights for unsecured loans, grew at just about 10% year-on-year. Even corporate loans, where HDFC Bank was previously aggressive, witnessed a notable slowdown with an 11% year-on-year growth in Q3.
Investors are advised to prepare for a departure from the norm, with the focus shifting to the liabilities side of HDFC Bank’s balance sheet. Despite the bank’s near-term emphasis on deposits, the pace of deposit accretion appears to be slowing. Total deposits grew about 28% year-on-year but expanded merely two percent sequentially, hinting at the base effect catching up faster than anticipated.
Against an initial plan to add 1,500 branches in FY24, the bank added only 264 branches from March 31, 2023, to December 31, 2023. Maintaining a cost-to-income ratio at 40% is set to be a challenging task.
