Merger overhang to delay HDFC Bank's re-rating, caution analysts

From a long-term perspective, they see up to 40.4 per cent upside in HDFC Bank's stock as growth outlook remains intact

HDFC Bank Q2 review: Lack of clarity on regulatory approvals around HDFC Bank’s merger with HDFC will likely delay the lender’s re-rating, analysts said on Monday. While the management expects the merger to be completed earlier by Q1/Q2 of fiscal 2023-24, the stock’s up move may remain gradual, they said.

“Currently, a shareholders' meet is due on November 25, 2022, after which it may take up to another 7-8 months to complete the process. That said, clarity on the HDFC Life stake, and the merger structure from the RBI remains elusive,” said Anand Dama of Emkay Global, in a co-authored note with Heet Khimawat, and Dixit Sankharva.

The brokerage has maintained its long-term ‘buy’ rating, and target price of Rs 1,800 on the stock after its September quarter (Q2FY23) result as it believes unfavorable merger structure, and moderation in loan growth (particularly retail) due to the macroeconomic concerns remain key risks.

Analysts at Kotak Institutional Equities (KIE), too, have kept their ‘buy’ rating, and target price (Rs 1,750) unchanged as they believe the Street’s near-term concerns remain unaddressed.

“At our fair value, we believe that the long-term investment thesis of the bank looks quite solid. However, the near-term issue of the merger would continue to remain a key overhang as we need to have clarity on the various dispensations needed for a smooth transition. Hence, we do believe that the re-rating needs a longer time-frame in mind,” they said.

Motilal Oswal Financial Services concurred that the stock could perform gradually on the bourses as revenue, and margin revive further while the merger-related overhang remains till the completion of the process.

Long-term outlook intact

During the recently concluded quarter (Q2FY23), HDFC Bank reported a 20.1 per cent year-on-year (YoY), and 15.3 per cent quarter-on-quarter (QoQ) increase in net profit to Rs 10,605.8 crore.

Its net interest income (NII) grew 19 per cent YoY to Rs 21,021.2 crore, with core net interest margin (NIM) expanding around 10 basis points to 4.1 per cent on total assets, and 4.3 per cent based on interest-earning assets.

This was HDFC Bank’s first margin expansion in two quarters, and highest sequential growth in NII since Q2FY19.

“With incremental growth being largely led by retail / SME, further supported by faster re-pricing of the loan portfolio than deposits, margins should improve in the near-term. We are building-in margins (calculated) at 3.9 per cent, and 4 per cent for FY23, and FY24, respectively,” said Kunal Shah of ICICI Securities.

That apart, the Mumbai-based lender’s gross non-performing asset (GNPA) ratio, and net NPA (NNPA) ratio declined 5 bps, and 2 bps QoQ to 1.23 per cent, and 0.33 per cent, with slippages moderating to around Rs 5,700 crore (1.6 per cent of loans). Provision coverage ratio (PCR) was stable at 73 per cent, and restructured book fell to Rs 7,850 crore.

Given this, CLSA anticipates HDFC Bank’s stock is nearing the end of its underperformance period.

“Weaker operating profit growth, and merger-related execution risk dragged down HDFC Bank’s multiple over the past 12-18 months. However, with HDFC Bank’s multiple 30 per cent lower than in the past, improving core PPOP growth, and a good start to its deposit mobilisation (retail deposit mobilisation at Rs 73,000 crore in Q2), we believe it is at the end of its underperformance period. Its consolidated valuation of 2.1x FY24 book is also undemanding,” analysts at the global brokerage said.

On the bourses, shares of HDFC Bank climbed 1 per cent intra-day, before paring gains to end 0.3 per cent higher at Rs 1,446 apiece on Monday. In comparison, the benchmark S&P BSE Sensex settled 0.85 per cent higher, and the BSE Bankex 1.6 per cent up.