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HDFC Bank: Flawless operating metrics

Prudent practices have ensured earnings growth of 30%, but valuation appears stretched

HDFC Bank
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has been in news lately, as it left biggies of the behind in the valuation sweepstakes. It’s difficult to find fault with a bank that delivers 30 per cent growth quarter after quarter. Such is the precision that analysts now term it as the “same good old story”.

So, is it only consistency that makes HDFC Bank a coveted stock? No, it’s the combination of robust operating metrics and predictability that has earned it the safe haven status. The HDFC group – the bank and its mortgage lender parent – has emerged as a safe haven because of its prudent business strategy.

Right from inception, HDFC Bank has followed the mantra of chasing “profitable” growth, unlike many of its peers. Analysts say the bank does not compromise on asset quality. The bank’s lending is based on the credit score of the borrower and even its loan-to-value ratios are never aggressive. The bank’s management has consciously chosen to go easy on the in the past.

No wonder, the bank has maintained a net interest margin (NIM) of over four per cent for several quarters, which is the best in the industry. In Q1FY13, the bank has expanded its NIM by 10 basis points to 4.3 per cent, while other banks are seen to be struggling. The bank has been able to deliver superior earnings during challenging times because it has the ability to raise low-cost deposits (share of CASA deposits stands at 46 per cent) and lend at a higher rate. Despite the 24 per cent growth in the loan book, the bank’s net bad loans were a negligible 0.2 per cent in Q1.

Such a superior return-on-assets profile has driven up valuations to sky-high levels. The bank’s one-year forward price/book value for the last three years (between July-2009 to July-2012) has averaged 3.5 times. The bank’s price to book value for FY14 is 3.4x times. Though investors believe that the bank’s management and financials do merit such a premium, there’s little upside left. Research expects HDFC Bank to trade in the 3-4x P/BV band over the longer term, the middle of its long-term trading band. “Any valuation upside from here would depend on a sustained return on equity improvement outlook or a particularly favourable macro-environment, which we do not foresee in the near term,” adds Citi.

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