HDFC.BO HDFC IN. IND-AS transition dampens performance. Q1FY19 Result Update. Rating: BUY CMP: Rs2,029 TP: Rs2,287. July 30, 2018.

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1 ( IN) Rating: BUY CMP: Rs2,029 TP: Rs2,287 July 30, 2018 Q1FY19 Result Update Change in Estimates Target Reco Change in Estimates Current Previous FY19E FY20E FY19E FY20E Rating BUY BUY Target Price 2,287 2,228 NII (Rs.) 133, , , ,112 % Chng. (1.8) (2.5) PPoP (Rs.) 153, , , ,749 % Chng. (0.1) (1.2) EPS (Rs.) % Chng. (0.9) (2.5) Key Financials FY17 FY18 FY19E FY20E Net Int. Inc. 99, , , ,043 Growth (%) Op. Profit 114, , , ,636 PAT 74, , , ,622 EPS (Rs.) Gr. (%) (15.7) 15.3 DPS (Rs.) Yield (%) Margin (%) RoAE (%) RoAA (%) PE (x) P/BV (x) P/ABV (x) Key Data.BO IN 52-W High / Low Rs.2,053 / Rs.1,638 Sensex / Nifty 37,494 / 11,320 Market Cap Rs.3,428bn/ $ 49,916m Shares Outstanding 1,690m 3M Avg. Daily Value Rs m Shareholding Pattern (%) Promoter s - Foreign Domestic Institution Public & Others Promoter Pledge (Rs bn) Stock Performance (%) 1M 6M 12M Absolute Relative (2.1) Pritesh Bumb priteshbumb@plindia.com R Sreesankar rsreesankar@plindia.com Vidhi Shah vidhishah@plindia.com IND-AS transition dampens performance Quick Pointers New disclosure under IND-AS shows stress assets (gross stage 3) at 3.7% including weak standard accounts of 2.5% of loans page 2 Positive flow through has been lower while charge on opex from ESOPs & CSR has seen higher bearing on earnings than expectations s loan asset growth of 19% YoY was better than expectations of 18% YoY driven from both individual & non-individual but same was visible in NII growth of 21% YoY as (i) impact from IND-AS accounting on interest expenses (Rs1.1bn of impact) and (ii) slightly lower spreads on individual loan book. under the IND-AS accounting recognized certain weak standard assets under the Gross Stage 3 exposure (2.5% of assets) leading to utilizing the floating provisions to maintain PCR at 28%. The standard stressed assets remain paying in Ltd book, but either is financially weak or NPAs in other institutions. Additional disclosures are slightly negative but given strong capabilities, we don t see large risks. We see slight spread pressure in near term but has already taken increase in PLRs keeping spreads in tight band and asset growth is expected to be better. Maintain BUY with TP of Rs2,287 (up from Rs2,228) based on SOTP valuation with valued at 2.9x. Slower operational performance under IND-AS: NII growth was lower at 21% YoY (PLe: 27% YoY) as borrowing costs increased (lower under IND-AS last year) despite some gains on investment income and slight spreads coming off in the quarter by 1bps to 2.28% mainly in individual book. Management expects spreads to improve as increase in rates should benefit eventually on both individual & non-individual. Operating performance (adjusting to dividend income) was also impacted from CSR expenses recognized from P&L and ESOPs valued at market price compared to last year (under IND-AS). Improvement in assets growth: Loan growth was up 19% YoY as individual loan continued to benefit from lower base and improvement in volumes especially in lower ticket size. Non individual loan book also grew well at 18% YoY but improved lending towards LRD assets. Spreads improved in the nonindividual book by 4bps QoQ to 3.14% as took rate hikes much earlier on this segment, while individual book spreads were at 1.91% down 1bp QoQ on lag in pricing of loans for legacy portfolio. Increase in stress assets slight negative: Under the IND-AS disclosures, recognized additional 2.5% of assets as weak standard accounts from both individual & wholesale book, which is slightly higher, in our view. These accounts are paying but has seen weaknesses in these accounts and hence exposure at default (EAD) was at 3.7% of loans v/s GNPA of 1.18% (which is included in EAD) leading to utilization of floating provisions. Assumptions for LGDs on individual book was assumed at 8.3% and 21.9% on non-individual book. July 30,

2 Total Under IND-AS, has classified assets based on Exposure at Default: Stage 1: Performing Assets Stage 2: Under Performing Assets Stage 3: (a) Performing but identified as assets having some degree of stress; (b): Non-Performing Assets Ltd disclosed the Stage 3 Standard but stressed asset which was at 2.5% v/s 1.49% YoY but has come off significantly Total EAD on stage 3 is 3. on portfolio basis Exhibit 1: Stage 3 exposure at Default has come off QoQ under IND-AS Exposure at Default (EAD) % Q1FY19 Q1FY18 Chg. YoY Q4FY18 Chg. QoQ Stage % 94.90% (14)bps 94.17% 59bps Stage % 2.50% (96)bps 1.48% 6bps Stage 3 (a): Standard, stressed assets 2.52% 1.49% 103bps 3.24% (72)bps Stage 3 (b): Non Performing Loans 1.18% 1.11% 7bps 1.11% 7bps Total Stage 3 EAD % 110bps 4.35% 65bps The NPAs have slightly deteriorated Exhibit 2: Utilized floating provisions for considering the standard stressed assets As gross stage 3 assets increased, utilized the floating provisions on these weak standard assets to maintain its PCR at 28%. Asset Quality as per IND AS (Rs mn) Q1FY19 Q1FY18 Chg. YoY Gross Stage 3 138,660 82, % ECL Provision Stage 3 38,630 23, % Net Stage 3 100,030 58, % Coverage Ratio% Stage 3 28% -1.0% Gross Stage 1 & 2 3,607,380 3,083, % ECL Provision Stage 1 & 2 5,650 5, % Net Stage 1 & 2 3,611,730 3,077, % ECL Provision % Stage 1 & % 0.19% 0.0% July 30,

3 Exhibit 3: Q1FY19 Financials IND-AS accounting impacts NII & opex leads to lower than expected earnings IND-AS IND-AS I-GAAP P&L (Rs m) Q1FY19 Q1FY18 YoY gr. (%) Q4FY18 QoQ gr. (%) Interest on advances 88,588 77, , Other interest income 4,410 4, , Total interest income 92,999 81, , Interest expense 63,527 57, , Net Interest Income 29,472 24, ,110 (8.2) Capital Gains 2 18 (88.0) 3,006 (99.9) Total other income 6,519 1, , Total income 35,993 25, ,293 (8.4) Operating expenses 5,096 3, , Staff expenses 3,243 2, Other expenses 1,853 1, , Operating profit 30,897 21, ,972 (16.4) Core operating profit 30,895 21, ,966 (9.0) Total provisions 197 1,636 (88.0) 1,800 (89.1) Profit before tax 30,700 20, ,172 (12.7) Tax 8,800 5, , Profit after tax 21,900 14, ,462 (23.1) Balance Sheet (Rs m) Loan composition 3,719,880 3,135, ,594, Individual loans (%) Corporate loans (%) Others (%) Borrowings composition 3,325,260 2,863, ,206, Term loans (%) Bonds/ Deb./ CPs (%) Deposits (%) Ratios (%) Spreads (Cumulative) (1) 2.29 (1) - Individual Loan Spreads (1) - Non-individual Loan Spreads (4) NIMs (50) Asset quality Gross NPL Coverage ratio Others / Ratios Cost-income ratio Tier-I (230) Note QoQ numbers not comparable July 30,

4 Exhibit 4: Overall loan growth contributed from both individual & non-individuals Exhibit 5: Loan mix broadly remains towards individual lending Individual loan gr YoY Non-Individual loan gr YoY Individuals Corporates Others 25% 20% 15% 10% 5% 0% 3Q14 4Q14 31% 28% 28% 28% 68% 68% 68% 71% Exhibit 6: Deposit share moves up on mobilization Exhibit 7: Post some reclassification Bond mix is up 36% 35% Deposits Share 100% Term loans Bonds Deposits 34% 80% 33% 32% 31% 60% 40% 28% 2Q14 3Q14 4Q14 20% 0% 4Q14 Exhibit 8: Overall spreads very marginally weaker Exhibit 9: Spreads slightly came off in individual book NIM Spread Profile (RHS) Spread - Individual Biz Spread - Non-Individual Biz 4.2% 4.0% 3.8% 3.6% 3.4% 3.2% 3.0% 2.35% 2.33% 2.31% % 2.25% 3.20% 3.00% 2.80% 2.60% 2.40% 2.20% 2.00% 1.80% 4Q14 Note Q1FY18 & Q1FY19 on IND-AS July 30,

5 Exhibit 10: Slight movement upwards in GNPLs 1.2% 1.1% 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% Net NPLs Gross NPLs Exhibit 11: both in individual and non-individual 2.6% 2.4% 2.2% 2.0% 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% Gross NPL - Individual Gross NPL - Non Individual Exhibit 12: Earnings Change Table We factor in slightly weaker spreads, higher opex from CSR & ESOPs and AMC stake sale gain (Rs mn) Old Revised % Change FY19E FY20E FY19E FY20E FY19E FY20E Net interest income 135, , , ,043 (1.8) (2.4) Operating profit 152, , , , (0.4) Net profit 103, , , ,622 (0.2) (1.8) EPS (Rs) (0.2) (1.8) ABVPS (Rs) (0.0) (0.3) Price target (Rs) 2,228 2, Recommendation BUY BUY Exhibit 13: SOTP valuation table based on Mar-20 SOTP valuation Stake (%) Value per share (Rs) Basis Parent (A) 1,222 Avg. of EVA and twostage GGM, 2.9x P/ABV & 17.6x P/E Mar-20E Subsidiaries / Associates Bank Value of stake in Bank as per our fair value Life insurance Appraisal value & NBP AMC % of AUM General Insurance x forward earnings Others 89 Total subs/associates discount 1,065 Fair value (A+B) 2,287 Contribution of subs to total (%) 47 July 30,

6 Exhibit 14: We revise our TP upwards to Rs2,287 (from Rs2,228) mainly on increase from Bank valuations PT calculation and upside Fair price - EVA 1,228 Fair price - P/ABV 1,216 Average of the two 1,222 Target P/ABV 2.9 Target P/E 17.6 Value of subs/associates 1,065 Fair value of consol. entity 2,287 Current price, Rs 2,028 Upside (%) 13% Dividend yield (%) 1% Total return (%) 14% Source: PL Research Exhibit 15: Ltd 1 year forward P/ABV trends P/ABV 3 yr avg. avg. + 1 SD avg. - 1 SD Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 July 30,

7 Income Statement (Rs. m) Int. Inc. / Opt. Inc. 308, , , ,281 Interest Expenses 208, , , ,238 Net interest income 99, , , ,043 Growth(%) Non-interest income 23,095 69,122 33,817 35,102 Growth(%) (20.0) (51.1) 3.8 Net operating income 122, , , ,145 Expenditures Employees 3,888 5,175 7,606 8,518 Other Expenses 3,920 4,804 5,837 6,593 Depreciation Operating Expenses 8,368 10,460 13,915 15,509 PPP 114, , , ,636 Growth(%) (10.2) 16.0 Provisions 7,000 20,300 5,105 6,957 Profit Before Tax 107, , , ,679 Tax 32,840 28,949 45,146 52,057 Effective Tax rate(%) PAT 74, , , ,622 Growth(%) (15.1) 15.3 Balance Sheet (Rs. m) Source of funds Equity 3,177 3,352 3,424 3,424 Reserves and Surplus 392, , , ,695 Networth 395, , , ,119 Growth (%) Loan funds 2,797,322 3,199,121 3,721,765 4,329,143 Growth (%) Deferred Tax Liability Other Current Liabilities 120, , , ,591 Other Liabilities 25,125 52,742 55,379 58,148 Total Liabilities 3,339,182 3,993,409 4,639,225 5,331,000 Application of funds Net fixed assets 6,423 6,445 6,767 7,038 Advances 2,957,338 3,594,420 4,259,698 5,016,862 Growth (%) Investments 204, , , ,259 Current Assets 116,124 55,057 74,723 (17,618) Net current assets (4,668) (72,463) (59,173) (158,209) Other Assets 55,706 32,161 32,804 33,460 Total Assets 3,339,693 3,993,408 4,639,225 5,331,000 Growth (%) Business Mix AUM 2,477,288 2,907,863 3,366,192 3,983,849 Growth (%) On Balance Sheet % of AUM Off Balance Sheet % of AUM Profitability & Capital (%) NIM ROAA ROAE Source: Company Data, PL Research Quarterly Financials (Rs. m) Y/e Mar Q2FY18 Q3FY18 Q4FY18 Q1FY19 Int. Inc. / Operating Inc. 81,449 84,744 89,219 92,999 Income from securitization Interest Expenses 55,341 55,457 57,109 63,527 Net Interest Income 26,108 29,287 32,110 29,472 Growth (%) Non-Interest Income 6,161 38,960 7,183 6,521 Net Operating Income 32,269 68,247 39,293 35,993 Growth (%) Operating expenditure 2,130 2,274 2,196 4,966 PPP 30,021 65,852 36,972 30,897 Growth (%) (16.1) (14.9) (8.6) 9.4 Provision , Exchange Gain / (Loss) Profit before tax 29,071 64,902 35,172 30,700 Tax 8,060 8,200 6,710 8,800 Prov. for deferred tax liability Effective Tax Rate PAT 21,011 56,702 28,462 21,900 Growth AUM 3,702,55 6 3,857,27 8 3,983,84 9 4,161,84 9 YoY growth (%) Borrowing 3,002,96 0 3,079,78 0 3,199,12 1 3,325,26 0 YoY growth (%) Key Ratios CMP (Rs) 2,029 2,029 2,029 2,029 EPS (Rs) Book value (Rs) Adj. BV(Rs) P/E(x) P/BV(x) P/ABV(x) DPS (Rs) Dividend Payout Ratio(%) Dividend Yield(%) Asset Quality Gross NPAs(Rs m) 23,363 40,258 30,670 34,616 Net NPA(Rs m) 15,983 27,432 (8,972) (9,199) Gross NPAs to Gross Adv.(%) Net NPAs to net Adv.(%) (0.2) (0.2) NPA coverage(%) Du-Pont NII NII INCI. Securitization Total income Operating Expenses PPOP Total Provisions RoAA Avg. Assets/Avg. net worth RoAE Source: Company Data, PL Research July 30,

8 Price Chart Recommendation History (Rs) Aug-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 No. Date Rating TP (Rs.) Share Price (Rs.) 1 9-Oct-17 Accumulate 1,843 1, Oct-17 BUY 2,000 1, Jan-18 BUY 2,000 1, Jan-18 BUY 2,160 1, Apr-18 BUY 2,222 1, Apr-18 BUY 2,228 1, Jul-18 BUY 2,228 1,920 PL s Recommendation Nomenclature (Absolute Performance) Buy : > 15% Accumulate : 5% to 15% Hold : +5% to -5% Reduce : -5% to -15% Sell : < -15% Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly July 30,

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