HDFC twins are trading at historic valuation discount vs Sensex

Analysts expect trend to persist till FY23 end, in light of headwinds

For the first time since the 2008 Lehman Crisis, HDFC and HDFC Bank are trading at a valuation discount to the broader market. Historically, both these firms have traded at a significant premium to the benchmark BSE Sensex’s valuation.

Mortgage lender HDFC is currently trading at a price-to-book-value (P/BV) ratio of 2.45 times (x) on a consolidated basis, a 30 per cent discount to the Sensex P/BV ratio of 3.47x on Thursday. Ditto for HDFC Bank. India’s largest private sector bank is valued at 3x its book value at its current stock price, a 13 per cent discount to the index current ratio.

In contrast, in the last 15 years, HDFC has traded at a P/BV of 3.9x on average, nearly 20 per cent premium to the Sensex valuation ratio of 3.25x during the period.

HDFC Bank has traded at a P/BV of 4.4x on average in the last 15 years, a 34 per cent premium to the index valuation. The HDFC twins’ current P/BV ratios are around half their peak of nearly 6x. In fact, as recently as 2018, HDFC traded at 4x its P/BV and HDFC Bank at nearly 5x. (See the adjoining charts)

The two lenders’ price-to-earnings (P/E) multiple now is also lower than that of the Sensex. HDFC is now trading at a trailing P/E of 18.3x based on its consolidated earnings, 26.5 per cent lower than the Sensex’s 24.9x. Similarly, HDFC Bank’ current P/E is now 21 per cent lower than that of the Sensex. Historically, however, HDFC has traded at around 8 per cent premium to Sensex on average in the last 15 years, while HDFC Bank commanded a 30 per cent premium to the Sensex.

While the P/E multiple is the most common ratio to compare the valuation of listed companies, P/BV is preferred for banks and non-banking financial companies.

The sharp decline in the valuation ratio of the HDFC twins is primarily because of their poor stock performance in recent months. For example, HDFC stock price has declined 26 per cent from its 52-week high, touched in August, while HDFC Bank is down around 20 per cent from its September highs. In comparison, the Sensex is down 7 per cent from its highs made in October.

Analysts attribute the poor show to a sharp slowdown in loan and earnings growth of the companies. “Their recent numbers suggest the two companies are finding it tough to grow. In the past, HDFC and HDFC Bank always managed to grow their net interest income and profits by 20 per cent or higher annually regardless of the industry growth. They are now struggling to beat this industry,” says Shailendra Kumar, chief investment officer, Narnolia Securities.

This has resulted in their valuation de-rating. “The quality or the management premium is still there but the growth premium embedded in these two stocks for nearly two-decades is now gone,” adds Kumar.

Analysts say many long-term investors are now underweight on HDFC and HDFC Bank leading to a sell-off in the stocks that continue to weigh on the share price.

Analysts expect this trend to persist at least till the end of financial year 2022-23 (FY23) given headwinds such as single-digit growth in bank credit, rising bond yields, and cost of funds and continued pressure on margins.

Others, however, see a value in the current low valuation of HDFC and HDFC Bank. “Their depressed valuation is a great opportunity for long-term investors to accumulate the stocks. Both companies continue to grow faster than industry and I expect a re-rating of the stock in the next three years,” says G Chokkalingam, founder and managing director Equinomics Research & Advisory Services.