1:5,1:2 Splits: HDFC Bank Stock, ADR Drops 14-17% YTD; 'Too Big To Fail', 3 Brokerages Recommend Buy

India's largest bank in terms of valuation, HDFC Bank fell short of bulls' glory in early 2024, and it's still in a recovery phase. Not only did share price on Indian stock exchanges take a beating, but also HDFC Bank's American Depositary Receipts (ADR) emerged as the top underperformer on the NYSE. Year-to-date, HDFC Bank's stock and ADR have plunged in the range of 14% to 17%. But this only brings a buy-on-dips scenario.

BULL CASE FOR HDFC BANK:

There are a couple of things that need to be understood when it comes to HDFC Bank. First, it is too big to fail as per RBI even now. Secondly, the bank's near-term outlook is under pressure but HDFC Bank is all about long-term takeoffs. Thirdly, it's a blue-chip and one of the fundamentally strong banks and hence a long-term wealth-creating stock.

As late-market mogul Rakesh Jhunjhunwala once said, "Always go against the tide. Buy when others are selling and sell when others are buying." This might be a true potential for HDFC Bank.

On March 15, HDFC Bank's share price stood at Rs 1,452.20 apiece, marginally down on BSE with a market cap of Rs 11 lakh crore. Similarly, HDFC Bank's ADR was in red but broadly flat at $55.23.

So far in 2024, HDFC Bank's share plunged by 14.33%, while its ADR has shed 17.10% as of now.

The reason why investor sentiment took a backseat in HDFC Bank is because of the overhang in its lending and deposit growth which was a bitter reality in Q3FY24 due to the merger of parent HDFC.

HDFC Bank underperformed its entire banking sector during Q3FY24. As per LKP Securities, the bank saw merger overhangs, higher operating expenses (C/I: 40% of 3QFY24), reducing yields (owing to higher HL of HDFC Ltd) and marginally reducing ROA (~2% for 3QFY24).

In recent times, there has been an assumption that HDFC Bank's near-term loan growth is likely to be around 10%, which seems to be not enough from investors' perspective.

Analysts at Bernstein said, "Is 10% a more realistic assumption for HDFCB's near-term loan growth?" - In the last few weeks, this has been the most common investor question on HDFC Bank."

Bernstein's analysts further listed sources of concern in HDFC Bank that have kept its share price and ADR in red still. They said, "While the weaker deposit growth has led to more moderate credit growth expectations across the sector, for HDFCB in particular, the extrapolation of management's comments on the usage of incremental deposits (reserve maintenance, eHDFCL liability replacement and growth- in that order) has raised questions on whether a loan growth of ~10% would become a harsh reality for HDFCB, during the transition phase."

Is 10% near-term loan growth not enough? Bernstein shed deeper light on this probable scenario for HDFC Bank ahead. What would it take? So, Bernstein pointed out that a sharp drop in loan growth could occur either from:

- Firstly, a decline in HDFCB's loan growth to ~10% will require assumptions of sharply lower system growth and low incremental market shares for HDFCB. E.g., Concurrent assumptions of system deposit growth dropping to ~10% and HDFCB's incremental market share being only ~15%. These scenarios would negatively impact EPS growth (in line with the decline in loan growth) but are unlikely to play out given the recent trends of system growth and HDFCB's incremental market shares.

- Secondly, a deliberate management choice! This would appear to be an extrapolation of management's recent comments on the usage of incremental deposits, with growth prioritization falling towards the end of the pecking order, behind the replacement of high-cost eHDFCL liabilities. Loan growth can indeed decline to ~10% even with a deposit growth of 18%-20% if the bank uses deposits primarily to run down maturing borrowings and not add any fresh borrowings.

However, Bernstein added that assuming that EPS growth maximization is the primary metric that management solves for (and not LDR reduction), they don't expect loan growth to drop to ~10% unless the bank can be selective in the loan segments that it grows in, in which case the EPS impact from slower loan growth would be minimal.

Hence, Berstein maintains an overweight on HDFC Bank stock. The brokerage's note added, "We moderate our loan growth marginally to ~15% in FY25E and FY26E (lower vs. previous estimates by ~1pp) but assume an offsetting margin benefit resulting in a near unchanged EPS estimates for FY24E-26E period. No change to Target Price of INR 2,100." This will imply a massive 45% upside ahead in HDFC Bank.

LKP Securities analysts are also optimistic about HDFC Bank. They have recommended a strong buy!

In its note, LKP's note added, "HDFC Bank is expected to overcome the merger overhangs gradually led by 1) healthy balance sheet growth, 2) much higher provision than the regulatory requirement in the balance sheet, 3) best in class underwriting and risk management practices. Given these strengths we expect HDFC Bank to remain one of the best among all the lending businesses. Thus, we continue to maintain a BUY rating (given historically lower valuation) on the bank with a revised target price of Rs1,762." This would be a potential 21.3% surge in HDFC Bank ahead.

Further, Kotak Institutional Equities highlighted that re-rating in HDFC Bank is slower and similar case is a theme in banking sector currently.

Kotak's note also said, "With HDFC Bank significantly de-rating with its peer's post-merger, we would probably look at the following as the near-term investment theme: The probability of the bank getting back to its historical average multiple or peak multiples looks unlikely unless there is a perceptible change in the cost of equity as there are differences in growth (slower today)."

"We would probably want to look at a possible convergence of multiples with peers, but only over the medium term, as these high-cost borrowings would eventually get replaced. We maintain BUY and revise FV to Rs1,750 (from Rs1,860), factoring in slower loan growth. We expect the bank to deliver RoEs of ~16-18% in the medium term," Kotak's note added. This would imply a potential of 20.50% upside in HDFC Bank ahead.

Due to the latest downfall, HDFC Bank's share has also corrected on a year-on-year basis. Its stock is down by 7.50% currently on YoY, while its 5-year upside is squeezed to 28%. But HDFC Bank's all-time gains is humungous 26,253%. In less than 15 years, HDFC Bank has rewarded investors on several occasions.

HDFC Bank Stock Split: The bank has significantly split two times, becoming affordable for investors before surging in long. Stock splits increase demand for a stock, improve liquidity and further become cheap. HDFC Bank had that scenario twice. The first stock split was of a 1:5 ratio in July 2011, where its face value of Rs 10 was trimmed to Rs 2 each. Followed by another stock split of 1:2, where the face value slipped from Rs 2 to Rs 1.

HDFC Bank Dividend Payout: As per Trendlyne data, HDFC Bank has delivered 24 dividends since April 2001. In the last 12 months, the company paid a dividend of Rs 19 per share. Currently, it has a dividend yield of 1.31%.

HDFC Bank Q3 Earnings: In Q3FY24, HDFC Bank's net profit came in at Rs 16,372 crore, registering a growth of 33% from Rs 12, 259 crore a year ago same quarter. While its net interest income (NII) saw a growth of 24% YoY to Rs 28,470 crore. While the bank's core net interest margin was at 3.4% on total assets, and 3.6% based on interest-earning assets.

Disclaimer: The recommendations made above are by market analysts and are not advised by either the author or Greynium Information Technologies. The author, the brokerage firm nor Greynium would be liable for any losses caused as a result of decisions based on this write-up. Goodreturns.in advises users to consult with certified experts before making any investment decision.