HDFC Bank: Merger, valuation concerns may weigh in near-term, say analysts

HDFC Bank Q4 result analysis: We have seen a de-rating of the bank's multiple in recent years and we are again at a point where the risk of further de-rating is high, analysts say

Shares of HDFC Bank bled on the bourses on Monday as analysts foresee prolonged underperformance by the stock after a disappointing set of March quarter (Q4FY22) results. The stock tanked 4.7 per cent to Rs 1,395 apiece on the BSE as against a 2 per cent slide in the BSE Sensex.

According to experts, the stock is unlikely to be an outperformer among large banks in the near-term as the overhang of the merger with HDFC, and lack of differentiation in underwriting or return ratios post Covid are weighing heavily on the valuation multiple. Most brokerages have cut their target prices on the stock factoring-in the weak Q4 result and near-term overhangs.  

"Concerns around final shape of the merger, eventual cost of the transition given the uncertainties on various regulatory compliances, the path to compliance, ability to sustain industry-leading growth rates, and return on equity and/or asset ratio (RoE/RoA) post the merger may remain overhang on the stock over the next 12-18 months," noted analysts at Kotak Institutional Equities.

There is a buffer to our earnings estimates as the bank could always draw down on its contingency buffer, but we are not sure if this would be a favorable outcome from a valuation perspective. We have seen a de-rating of the bank's multiple in recent years and we are again at a point where the risk of further de-rating is high if more uncertainties arise during the merger, they added.

On Saturday, HDFC Bank reported a 22.8 per cent year-on-year increase in net profit for the Jan-March quarter to Rs 10,055.2 crore, compared to Rs 8,186 crore the same period of the previous year. The rise was mainly due to reduction in provisions by almost Rs 1,300 crore. The net interest income (NII) of the bank, meanwhile, grew by 10.2 per cent to Rs 18,872.7 crore on the back of 20.8 per cent growth in advances. Both PAT and NII were below Street estimates of 30-40 per cent and around 20 per cent YoY growth, respectively.

The bank's core net interest margin (NIM) was 4 per cent on total assets and 4.2 per cent on interest earnings assets. Further, core pre-provision operating profit (PPoP), up 10 per cent YoY/4 per cent QoQ, was slowest-ever, and lagged loan growth for a second quarter in a row.

"While loan growth stood strong at 21 per cent YoY and 8 per cent QoQ, NII growth was slower at 10 per cent YoY and 2 per cent QoQ as NIM declined 10 basis points QoQ. Retail loans, up 15 per cent YoY/5 per cent QoQ, outgrew the system's 12 per cent YoY. However, stronger-than-expected growth in lower-yielding corporate loans (17 per cent YoY) and commercial banking loans (31 per cent YoY) weighed on margins," explained analysts at Edelweiss Securities.

Those at Emkay Global added: Retail credit growth (15 per cent YoY/4 per cent QoQ) lagged overall credit growth (21 per cent YoY/9 per cent QoQ on corporate/commercial credit growth), with the share of retail down to 45 per cent, thus weighing on core margins.

"Management argues that the focus is on risk-adjusted margins, which have improved sequentially to 3.5 per cent from 3.1 per cent. It expects retail growth to improve, driven by unsecured loans, providing some support to margins. However, we believe that the rising share of mortgages/higher fixed-rate loan books could keep margins in check in the near term," they said.

Edelweiss Securities, further, says RoE would remain at 16–17 per cent over the medium-term against the standalone peak RoE of around 19 per cent due to merger with HDFC. "Our target price stands revised to Rs 1,860 from Rs 2,000 as slowing PPoP growth and merger uncertainty would weigh on near-term performance," they said.

That said, from a long-term perspective, Motilal Oswal Financial Services says HDFC Bank could deliver around 20 per cent PAT CAGR over FY22-24, with an RoA/RoE of 2.1 per cent/17.8 per cent in FY24 as the stock could recover gradually due to revenue and margin reviva; over FY23, while clarity emerges on several aspects related to the merger with HDFC Ltd.