Mr Aditya Puri MD and CEO. HDFC Bank. It s all about being digital. Key takeaways from CEO Track

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1 BSE Sensex S&P CNX 28,797 8,867 Detailed Report Sector: Financials CMP: INR1,291 TP: INR1,450 (+12%) Buy Mr Aditya Puri MD and CEO CEO TRACK Stock Info Bloomberg HDFCB IN Equity Shares (m) Week Range (INR) 1,305/929 1, 6, 12 Rel. Per (%) 1/9/15 M.Cap. (INR b) 3,264 M.Cap. (USD b) M Avg Val (INR M) 1,637 Free float (%) 78.6 Financial Snapshot (INR Billion) Y/E Mar 2017E 2018E 2019E NII OP NP NIM (%) EPS (INR) EPS Gr. (%) BV/Sh. (INR) ABV/Sh. (INR) RoE (%) RoA (%) Payout (%) Valuations P/E(X) P/BV (X) P/ABV (X) Div. Yield (%) Relative to Index It s all about being digital Key takeaways from CEO Track Significant investment in digital initiatives has begun paying off: (a) ~20% of incremental unsecured personal loans sourced through 10-second personal loan product, (b) 8-10% of auto loans sourced through digital channel, (c) volumes on SmartBuy, HDFCB s online market place almost 1/10th of Amazon s volumes. HDFCB s digital journey will continue through collaborations/partnerships. It is committed to platform-agnostic services. Lot of technology initiatives are in store expect rollout by March 2017 (robots in branches, artificial intelligence). Significant investments in branches and technology would provide operating leverage and efficiency in ensuing quarters. Expect cost-to-income ratio to decline, led by higher business volumes. HDFCB remains a picture-perfect story, with (a) continued market share gain (12.5% incremental share (9.2% for )), (b) adequate capitalization (CET1 of 13.3%, best in class), (c) CASA ratio of 40%+, (d) best in class profitability, with 1.9% RoA and 18.3% RoE. Subsidiaries have become sizeable based on multiple of 15x for securities business and 3x BV for NBFC business, per share value for HDFCB works out to INR58 (post HoldCo). Digital journey customer focus and ease of business key effort areas HDFCB s digital strategy is centered around (a) increasing efficiency, (b) accelerating geographic expansion, (c) raising customer convenience and ease, and (d) competing against disruptive technology. It is already seeing strong success in 10- second personal loans (20% of incremental sourcing through this channel), preapproved auto loans (8-10% of disbursements), and SmartBuy (10% of Amazon s volumes). It plans to use artificial intelligence for routine work and most initiatives are likely to be launched by December With these initiatives gaining traction and incremental business coming from these channels, the management is confident of reducing the cost-to-income ratio. Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com) Krishnan ASV (A.Krishnan@MotilalOswal.com); / Rahul Gupta (rahul.pgupta@motilaloswal.com); September Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 has gained significant market share across segments Payments business significant market share gains In payments solutions, HDFCB has presence across segments B2B, B2C, P2P, etc. UPI is a strong enabler for financial inclusion and cashless economy. The bank has gained market share in RTGS (19%), NEFT (13%), mobile banking (23%), credit card transactions (31%), and POS transactions (8%). With digital initiatives, the management expects its leadership to strengthen. Working capital demand improving; rural/semi-urban retail demand strong HDFCB is seeing improving demand for working capital. However, capex demand is still a year away. For capex, corporates await strong signals like acceleration in GDP to 8%+, revival in global growth, etc. HDFCB s strong expansion in rural and semiurban areas is leading to strong traction in retail and SME business. While overall demand is slow in such locations, HDFCB s focus on top 25% population in such locations for loan products is leading to strong growth. Operating parameters best-in-class; adequately capitalized Mr Puri remains confident about HDFCB s ability to grow at least 1.3x the system and gain market share. With impeccable asset quality, strong control over core income parameters and expected operating leverage, profit growth should remain healthy. Strong expansion in rural and semi-urban locations would drive healthy growth in the years to come. s subsidiaries have become sizeable now and the management remains upbeat on the business ROE is expected to be ~19-20%. We value HDFCB at INR1,450 per share, implying 3.5x Sep-18 BV Subsidiaries gaining strength strong growth ahead HDFCB s subsidiaries have become sizeable the NBFC s AUM is INR260b (comparable to CIFC) and HDFC Securities topline is INR4b. HDB Financial Services has expanded rapidly and makes 2.4% RoA and 16% RoE. The management remains upbeat on the business. HDFC Securities also makes healthy RoE of 21%+, with a PAT margin of 33%. Value accretion in these businesses is significant. Our back-of-theenvelope calculation suggests total value of INR182b for both businesses. Post HoldCo discount, the value per share for HDFCB works out to be INR58. Best-placed private-sector bank HDFCB is well positioned in the current environment, with ~40% CASA ratio, growth outlook of at least 1.3x industry, and least asset quality risk. With CET1 of ~13.3%, strong capacity building amid the moderate growth cycle (branches at 4,541 v/s 1,412 in ) and significant digitalization initiatives, the bank is well placed to benefit from the expected pick-up in the economic growth cycle. HDFCB is the second largest bank in the country after SBI, now with a market share of 5.7%. RoE is expected to be 19-20% in FY18/19. Comfort on earnings remains high. We maintain our RI-model-based target price of INR1,450 (3.5x September 2018E BV). September

3 Exhibit 1: Market share across products NEFT - Values RTGS - Values RTGS - Volumes Debit Cards (Values) Credit Card Transactions - Values Mobile Banking Source: RBI, Company, MOSL Share of internet / mobile based transactions has increased from 55% in to 71% in. Exhibit 2: Leveraging technology should lead to cost efficiency, as digital transactions cost ~1/10th of branch-based transactions 97 Branches ATM Phone Banking Internet & Mobile FY01 Exhibit 3: Key digital offerings of Chillr Smartbuy PayZapp Mobile Banking App An app that lets you send money immediately to anyone in your phone book, 24x7 SmartBuy is a marketplace / platform, that has tied up with various merchants, for display of offers extended by merchants to HDFC Bank's debit / credit card customers Can also send money without its customers by providing the sharing mobile numbers with Chillr Payment Gateway Services and does App users in your vicinity, using not earn any fee by hosting this 'Near Me' option website Recharge your mobile, DTH and data cards Immediate transfer money between bank accounts A complete payment solution, giving you the power to pay in just One Click. You can shop on your mobile at partner apps, buy movie tickets, facilitates the payment by music and groceries, compare and book flight tickets and hotels, shop online, send money to anyone in your contact list, pay bills and recharge your mobile, DTH and data card. MobileBanking App for Android helps you check your account balance, transfer funds, pay your bills, etc. You can access 75+transactions anytime, anywhere, using your fingertips Source: MOSL, Company September

4 Exhibit 4: Loans grew at CAGR of ~30% over Market Share in Loans (%) Exhibit 5: while deposits grew at CAGR of ~26% Market Share in deposits (%) Source: RBI, MOSL, Company Source: RBI, MOSL, Company Exhibit 6: CA market share Exhibit 7: SA deposit share CA mkt share (%) SA mkt share (%) Source: RBI, MOSL, Company Source: RBI, MOSL, Company Share in profits continue to rise given PSU Banks are marred by asset quality concerns. Exhibit 8: Profit share tripled at the expense of PSU banks (PAT MS, %) PAT Market Share (%) Private Banks PAT Market Share (%) Source: RBI, Company, MOSL September

5 Exhibit 9: Branch additions at 3x industry average (branch MS, %) Exhibit 10: Customer base has increased sharply (~4m), led by network expansion (m) ~2m customers added from CBOP FY Source: RBI, Company, MOSL Exhibit 11: Incremental branches opened with focus on semi-urban and rural regions (branch mix, %) Metro Urban Semi-Urban Rural Exhibit 12: The bank is expected to add branches each year for the next three years Branches FY03 FY04 FY05 FY17E FY18E FY19E Exhibit 13: Share of retail deposits increasing, pointing to power of strong liability franchise (deposit mix, %) Saving Dep. Current Dep. Retail term dep. Corp. term dep Source: MOSL, Company Exhibit 14: The bank has a diversified loan book Gold loans, 2.4 Home loans, 15.6 Business Bkg, 13.9 Kissan gold cards, 9.6 Credit Cards, 9.8 Others, 4.4 Com. Vehle & const equip, 11.8 Auto Loans, 25.1 Personal Loans, 16.7 Two wheeler, 2.5 Loan against securities, 0.6 Source: MOSL, Company September

6 Exhibit 15: Best-in-class asset quality NNPA (%) OSRL (%) 5:25 SDR PNB OBC CBK BOI BOB INBK UNBK SBIN ICICIBC AXSB YES 0.4 HDFCBK Exhibit 16: Sustaining high internal capital generation rates remains key RoE (%) RoA (%), RS FY03 FY05 Capital Raised FY17E FY19E Exhibit 17: AUM has become substantial for HDB now Exhibit 18: Asset quality worsened but still at low levels AUM (INR Bn) Disbursements (INR Bn) Disbursements Growth (YoY, %) Exhibit 19: Profitability continues to show uptrend Exhibit 20: HDFC Securities profitability still at high levels ROA (%) ROE (%), RHS PAT Margin (%) ROE (%) September

7 Best getting better Market share gains to accelerate; 20%+ earnings CAGR Market share in loans has increased by 3% points in the last 5 years to 5.7%; second only to SBIN. Finding opportunity in adversity continues to gain market share Historically, HDFCB has capitalized periods of adversity or weak competition to gain market share in each product category. It is the leader in most retail products, with a market share of at least 10%. In two decades since its inception, HDFCB has become India s second largest bank (largest private bank). Its loan market share as of stands at 5.7%. Retail loan growth is seeing strong revival, with rising contribution from high RoE retail products like unsecured personal loans, LAS and credit cards. Despite moderate growth in underlying assets like auto, CV and CE loans, HDFCB is seeing strong loan growth, indicating market share gain. Given that HDFCB is likely to grow at least 1.3x the industry growth, we expect market share gains to continue and reach 7% by FY19. Operating leverage to drive profitability Led by strong loan growth, revenue growth remains healthy at 20%+ over the last seven quarters, giving HDFCB avenues to expand aggressively (branches up 11% YoY, headcount up 12% YoY) and invest in digitalization without much impact on cost ratios (C/I ratio remains at 45-47%). We expect core revenue to grow at 20%+ hereon. Cost-to-income ratio should continue to decline (to 43% by FY19), as the share of incremental sourcing from digital channel increases and overhead cost declines with the use of technology. HDFCB boasts of one of the best operating parameters in the business. Best operating parameters in the country HDFCB enjoys one of the best operating parameters in the country, with (1) CASA ratio of ~40%, (2) growth outlook of at least 1.3x industry growth, (3) best-in-class asset quality, (d) CET ratio of ~13.5%, and (b) 1.8%+ RoA and 19-20% RoE. Despite pricing pressure, NIMs are expected to remain at the current levels, with (a) pick-up in CASA growth, (b) benefit of falling rate cycle due to high share of fixed rate retail loans (~70% of book), and (c) rise in contribution of high-yielding retail loans. HDFCB carries floating provisions of INR13b+, created to smoothen earnings growth, led by lower-than-factored credit cost on retail loans. Earnings CAGR of 20%+; re-iterate Buy We expect earnings CAGR of 20% (best amongst the large private banks). Core income growth would pick up, led by healthy loan growth, superior NIMs, gradual improvement in fee income, and operating efficiencies driven by digital initiatives. We maintain Buy, with a target price of INR1,450 (3.8x FY18E BV). Our key assumptions are (a) risk free rate of 7.5%, (b) risk premium of 5%, (c) beta of 0.9x, (d) average growth of ~15% over -36E, and (e) terminal growth rate of 5%. The stock trades at 3.3x FY18E BV and 18.4x FY18E EPS. September

8 Exhibit 21: One-year forward P/BV PB (x) Peak(x) Avg(x) 5.5 Median(x) Min(x) Sep-06 Dec-07 Mar-09 Jun-10 Sep-11 Dec-12 Mar-14 Jun-15 Sep-16 Exhibit 22: One-year forward P/E PE (x) Peak(x) Avg(x) 42 Median(x) Min(x) Sep-06 Dec-07 Mar-09 Jun Sep Dec-12 Mar-14 Jun Sep-16 Exhibit 23: DuPont: Return ratios to improve, driven by strong core operating performance (%) Y/E March FY17E FY18E FY19E Net Interest Income Core Fee Income Fee to core Income (%) Core Income Operating Expenses Cost to Core Income (%) Employee cost Others Core operating Profits Trading and others Operating Profits Provisions NPA Others PBT Tax Tax Rate (%) RoA Leverage (x) RoE September

9 Exhibit 24: Financials: Valuation metrics Rating CMP Mcap EPS (INR) P/E (x) BV (INR) P/BV (x) RoA (%) RoE (%) 66 (INR) (USD b) FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 ICICIBC* Buy HDFCB Buy 1, AXSB Buy KMB* Buy YES Buy 1, IIB Buy 1, IDFC Bk Buy FB Buy DCBB Buy JKBK Neutral SIB Buy Private Aggregate SBIN (cons)* Buy PNB Neutral BOI Neutral BOB Buy CBK Neutral UNBK Buy OBC Neutral INBK Buy ANDB Buy Public Aggregate Banks Aggregate HDFC* Buy 1, LICHF Buy IHFL Buy GRHF Buy REPCO Buy DEWH Buy Housing Finance RECL Neutral POWF Neutral Infra Finance SHTF Buy 1, MMFS Buy BAF Buy 1, MUTH Buy SKSM Buy Asset Finance NBFC Aggregate Financials *Multiples adj. for value of key ventures/investments; For ICICI Bank and HDFC Ltd BV is adjusted for investments in subsidiaries September

10 Financials and Valuations Income Statement (INR Million) Y/E March E 2018E 2019E Interest Income 350, , , , , ,643 1,017,809 Interest Expense 192, , , , , , ,387 Net Interest Income 158, , , , , , ,422 Change (%) Non Interest Income 68,526 79,196 89, , , , ,826 Net Income 226, , , , , , ,248 Change (%) Operating Expenses 112, , , , , , ,263 Pre Provision Profits 114, , , , , , ,985 Change (%) Provisions (excl tax) 16,770 15,880 20,758 27,256 33,741 39,205 55,914 PBT 97, , , , , , ,071 Tax 30,249 42,937 51,128 63,417 75,275 89, ,294 Tax Rate (%) PAT 67,257 84, , , , , ,778 Change (%) Equity Dividend (Incl tax) 15,360 19,275 24,142 28,790 34,428 41,381 49,810 Core PPP* 97, , , , , , ,782 Change (%) Balance Sheet (INR Million) Y/E March E 2018E 2019E Equity Share Capital 4,759 4,798 5,013 5,056 5,056 5,056 5,056 Reserves & Surplus 357, , , , , ,274 1,135,241 Net Worth 362, , , , , ,330 1,140,298 Deposits 2,962,470 3,673,375 4,507,956 5,464,242 6,557,090 8,130,792 10,082,182 Change (%) of which CASA Dep 1,405,215 1,646,214 1,984,921 2,363,108 2,865,307 3,474,453 4,213,367 Change (%) Borrowings 330, , , , , , ,075 Other Liabilities & Prov. 348, , , , , , ,397 Total Liabilities 4,003,319 4,915,995 5,905,031 7,088,456 8,474,150 10,321,216 12,593,951 Current Assets 272, , , , , , ,758 Investments 1,116,136 1,209,511 1,516,418 1,638,858 1,884,686 2,223,930 2,624,237 Change (%) Loans 2,397,206 3,030,003 3,654,950 4,645,940 5,668,046 7,028,377 8,715,188 Change (%) Fixed Assets 27,031 29,399 31,217 33,432 36,373 39,315 44,256 Other Assets 190, , , , , , ,512 Total Assets 4,003,319 4,915,995 5,905,031 7,088,456 8,474,150 10,321,216 12,593,951 Asset Quality (%) GNPA (INR m) 23,346 29,893 34,384 43,928 58,924 83, ,047 NNPA (INR m) 4,690 8,200 8,963 13,204 20,547 25,555 44,240 GNPA Ratio NNPA Ratio PCR (Excl Tech. write off) E: MOSL Estimates; *Core PPP is (NII+Fee income-opex) September

11 Financials and Valuations Ratios Y/E March E 2018E 2019E Spreads Analysis (%) Avg. Yield-Earning Assets Avg. Yield on loans Avg. Yield on Invt Avg. Cost-Int. Bear. Liab Avg. Cost of Deposits Interest Spread Net Interest Margin Profitability Ratios (%) RoE RoA Int. Expense/Int.Income Fee Income/Net Income Non Int. Inc./Net Income Efficiency Ratios (%) Cost/Income* Empl. Cost/Op. Exps Busi. per Empl. (INR m) NP per Empl. (INR lac) * ex treasury Asset-Liability Profile (%) Loans/Deposit CASA Ratio Investment/Deposit CAR Tier Valuation Book Value (INR) Change (%) Price-BV (x) Adjusted BV (INR) Price-ABV (x) EPS (INR) Change (%) Price-Earnings (x) Dividend Per Sh (INR) Dividend Yield (%) E: MOSL Estimates September

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