HDFC Bank Recommendation: Buy

Transcription

1 1 Prepared by: Mark Wood HDFC Bank Recommendation: Buy Key Highlights: HDFC Bank has unique positioning within the Indian economy against its competitors India s growing middle class allows for continual expansion of HDFC prime client base The mortgage market in India is prime for growth HDFC has developed innovative strategies against its competitors with respect to technology. DCF Highlights Current DCF values HDFC at approximately $73 vs. current market value of $55 The Indian market will provide high growth opportunities for the foreseeable future. Continued development of technology will help non interest income grow at a considerable rate. Company Profile: HDFC Bank Limited, a private sector bank, provides financial services to corporations, and middle and upper-income individuals in India. It has three divisions: Wholesale Banking, Retail Banking, and Treasury Operations. In addition, the bank provides telephone, Internet, and mobile telephone banking services. As of March 31, 2005, it operated 467 branches and 1,147 ATMs in 211 cities. Key Financial Information Recent Price Week High Week Low P/E Ratio TTM 30.90

2 Further Company Information 2 The Wholesale Banking division provides loans, deposit products, documentary credits, guarantees, bullion trading, and foreign exchange and derivative products. It also offers cash management services, clearing and settlement services for stock exchanges, tax and other collections for the government, custody services for mutual funds, and correspondent banking services. The Retail Banking division provides various deposit products, as well as loans, bill payment services, gold and silver credit cards, debit cards, third party distribution, investment advisory services, card and automated teller machine (ATM) acquiring transactions, and depositary services. The Treasury Operations division offers foreign exchange and derivative products for its clients. The company was incorporated in 1994 and is headquartered in Mumbai, India. 1 Indian Banking History In the 1960 s the Indian government set out on a policy of nationalizing all of the major banks, and effectively putting them under the control of the Indian government. The first wave in the late 1960 s consisted of the leading fourteen banks, and the second wave of nationalization occurred in 1980 s which consisted of six additional banks. 2 The nationalization of banks significantly alters the priorities of those institutions from profit maximization to doing the will of the Indian government. In 1990 s, the Indian government embarked on a policy of liberalization of banks within the Indian economy. This liberalization finally allowed once again for private banks to operate with little interference from the government. These banks were given the nick name the New Generation tech-savvy banks. 3 The first private bank to begin operation under the new flag of liberalization was HDFC Bank, which began operations in Yahoo Finance

3 HDFC Unique Positioning 3 HDFC incorporated without any government ownership, allowing it to have a very unique position within the Indian economy. Even though HDFC did not suffer from government ownership, its major competitors did. Up to this day, nineteen different Indian banks are considered nationalized. 4 Private banks without any government ownership generally are held liable by their shareholders and generally strive to maximize profits. In addition, without any government ownership these organizations face a real potential for going bankrupt without any help from the government. These realities encompass a hard budget constraint, which means the organization faces a real chance of death; the management will have more of an incentive to grow and expand the business. The government ownership of these banks conceivable changes the priorities of these banks from profit maximization to abiding by what priorities the Indian government lays down. If the Indian government decides that the additional growth is necessary within small business loans; the Indian banks will feel pressured to issue all loans that are in relation to small business s even if they may result in a lose. In addition, government controlled banks will fear bankruptcy less because of the fact their organization is owned by the Indian government. This mentality will result in these organizations being run less efficiently as well as less emphasis placed on profit maximization. Therefore, HDFC, one of the few private banks in India with profit maximization as its sole priority competing against government controlled banks with possibly multiple priorities in one of the premier growth markets. The Growing Indian Middle Class The central customer base for HDFC is India s middle class and upper class. In the last ten years the percentage of the population that makes up the middle class has doubled from 7% to nearly 15%. 5 The current economic growth of seven percent will probably be maintained for the foreseeable future allowing for additional growth in the middle class. By all accounts, if the growth rate is maintained then half of India will turn middle class between 2020 and ryid%3d2195+the+growing+indian+middle+class&hl=en&gl=us&ct=clnk&cd=1 6 ryid%3d2195+the+growing+indian+middle+class&hl=en&gl=us&ct=clnk&cd=1

4 4 These potential growth prospects for HDFC are enormous especially with their key client base will experience so much growth over the next two decades assuming that current growth rates are maintained. HDFC Present Strategy Mortgages In India HDFC present strategy concentrates greatly around the growth of the Indian mortgage market. At present mortgage payments only contribute approximately 3 percent of India s GDP as compared to other countries with significantly bigger mortgage markets. HDFC believes it can break the cultural barrier and expand into the Indian mortgage market, which has the potential for tremendous growth. Factors working for a good market scenario: - Rising Disposable Income - Low Interest Rates - Generally Stable Property Prices - Increased Urbanization - Housing Shortages 7 Percentage GDP Paid to Mortgages vs. Individual Countries 70% 70% 54% 60% 48% 49% 51% 50% 36% 37% 40% 30% 23% 20% 9% 13% 10% 3% 0% India Thailand Korea Malaysia Singapore Taiwan Germany Hong Kong USA UK Denmark 7

5 HDFC has the ability to expand the present Indian mortgage market because of the ideally strong market climate, but also because HDFC has the home court advantage in respect to culture in India. Like most culture, Indians would like to borrow from a local bank rather than a foreign controlled bank such as Citigroup or HSBC. Additional Key Strategies HDFC management during late 2005 and early 2006 redefined its business strategy to focusing on high yield loans. The type of loans these consist of are: - Personal Loans - Credit Cards - Two Wheeler Loans This emphases has lead to a margin expansion of between basis points, but it must be added that this refocusing carries additional risk with defaults on credit cards potentially are higher. In addition to loan growth, non interest income has also seen a tremendous growth pattern and is sure to see similar growth in the future because of Technology. HDFC invests heavily in technology whenever possible to develop an environment of information technology and communications systems. One way HDFC uses technology to increase revenue is through ATM fees. From 2004 to 2005, fee incomes has grown by nearly 83 percent. 8 The fees income growth should maintain a positive growth pattern as HDFC continues to expand and grow in the Indian market. HDFC will continue to look for additional ways to use technology to maximize profits whenever possible. Discounted Cash Flow Analysis The discounted cash flow model was set up on the basis of market estimates with emphases placed on higher long term growth potentials. The risk free rate chosen is 4.25 percent with the market premium being 6.25 percent. The equity beta chosen for the model is 1.5, which is based off a composite of many sources which include Bloomberg and Yahoo Finance. HDFC is a international company with no direct operations within the North American hemisphere, and thus is not watched as closely as other major banks. 5 8 Company Financials

6 6 Date of valuation 3/23/2006 Risk Free Rate: 4.25% Equity Market Risk Premium: 6.50% Long term inflation: 2.50% Terminal Growth: 5.00% Equity beta: 1.5 No. of shares (diluted): 103,821,062 Current Market Price per share: $53.77 Projected Market Price per share: The discounted cash flow model puts the estimated stock price per share at approximately $ The model takes into account of very high income growth for the next several years upwards of near 30 percent. This is based off previous years growth with a historic average of 33 percent on interest income alone. HDFC consistently over the previous quarters has beat street expectations. The model continues the high expectation of interest income growth through 2009 with a downward trend. From 2010 to the terminal date the growth of interest income is reset to a more modest 9-11 percent, and is also trimmed downwards. The terminal interest income growth is left at nearly 11 percent primarily taking into account the increase of the middle class within India over the next three decades. The non interest income additionally was kept at very high growth rates for the next several years because of the historic average of percent. As with interest income, in 2010, non interest income was also trimmed back to a modest rate of 10 percent. This part of the model is highly considerate on the part of HDFC to find additional ways of making money through fees. At this point, fees are an acceptable way to make money within the banking industry, but this may be a potential for a competitor to promote less fees with our bank.

7 7 Comparables The only company that HDFC can be effectively compared with is a similar private bank in India known as ICICI Bank. Other competitors exist such as government controlled banks, but these banks do not report in the United States as HDFC and ICICI do. Research was conducted to attempt to translate financial data from several government controlled banks into comparables, but the necessary time required exceeded the potential information gained. In addition, consideration was given to other international banks such as Bank of America and Citigroup. Bank of America and Citigroup represent very large international banks that have operations in dozens of countries, while HDFC operates only within India. This is one reason the comparable analysis is not a very strong argument to make. In addition, the banking structure of India is so distinctly different from other countries that any conclusions assumed from using comparables between HDFC and a large international bank would have be look upon with skepticism. Bank of America and Citigroup financials make up their India operations as well as all of their other operations. Highlights HDB Citigroup IBN BOA Price / EPS (TTM) Price / EPS (07) LTM Sales (Revenue) $ LTM EPS* $ $0.73 The highlights from the comparables data identify HDB undervalued with respect to IBN in regards to the current Price to Earnings ratio, but the forward P/E ratio seems to rectify the undervaluation during The earnings per share data are also very comforting with HDB maintaining very nice margins when compared to its biggest competitor. Concluding Thoughts The premise of this buy recommendation is built on the assumption that HDB has a very unique position within its current market, with a great ability of growth over the next ten years and beyond. Assuming HDB can maintain its current management style, and growth expectations maintain themselves, then HDB should be a very successful buy for the future.

8 8

9 9

10 10

11 11

12 12

13 13

14 14