Can HDFC Bank share bounce back post the recent slump of more than 30%

One of the most successful business stories, that will be written down in India’s corporate history books, is of this giant called “HDFC Bank”. It is the most successful and the biggest private sector bank in the country. This bank’s journey was started by a Citibank veteran, Mr. Aditya Puri who became the longest serving CEO and Managing Director of any financial institution in India. No wonder! A bank which has grown to a deposit base of INR 11,475 bn and gross advances of INR 9,937 bn with a profit after tax of INR 263 bn by March 31st, 2020, it means something (India’s GDP is ~INR 2,10,000 bn, which means HDFC’s deposits are ~5.5% of GDP! Phew! Imaging this bank going bust!). Despite all of this, this bank’s equity share has declined by more than 35% since the lockdown was announced. It can be disturbing for many as the explanation of this could EITHER be that the investors expect HDFC’s revenue and profits will decline by more than 25–30% next year hence the actual price is the true reflection of things to come (shores area usually valued as a multiple of revenue, profit or total assets for anyone who is not an avid investor) OR investors are worried about HDFC’s future in general (Given that Aditya Puri is about to leave HDFC as he turns 69 and his successor’s search has not yielded a result in last 18 months and banking as a whole may just see a very very bad time in terms of bad loans).

Whatever may be the reason for investor pessimism, I can’t resist drawing parallels from 2008 Sub prime mortgage crisis, thanks to a very interesting report by Saurabh Mukherjea lead Marcellus Investment Managers. He explained the concept of consistent compounders and showed how shares of strong companies like HDFC Bank, Nestle, Asian Paints etc. have grown by more than 5 times, of their market cap post 2008, in the last 11 years. That crisis was the harshest on the banks and even this one doesn’t seem to have given them any leeway. Then HDFC Bank fell by more than 40% after the crisis but recovered within 6 months. But what about now?

This crisis seems to be much bigger for India as opposed to the 2008 crisis as the crisis then had its origins and remains in US. Given the global economy, repercussions were felt in India too but it didn’t lead to a decline in GDP of same or worse extent, as is being expected in FY 21 post Covid (GDP dropped from 7.8–7.9% growth in 2008 to ~5.8–5.9% growth in 2009) then certainly this is a far worse economic scenario and if GDP declines such that the growth slides to negative then it would mean that industries will shrink and so will the credit availed by them while the defaults will increase. But which industry will face the biggest challenge? Which corporates? Will all of it fall in the lap of the big banks or will smaller banks become the sacrificial lamb? What about high risk NBFCs whose underwriting is riskier than banks with limited fall back option on deposits?

My simple take away on a very very broad level, despite all number crunching and analysis, is when the economy starts hurting even its bluest of the “Bluechip” companies, it would be the end of things. Think of it like a Tsunami. The first ones to get affected are the housing establishments close to the sea and then the Tsunami moves inwards. Think of the biggest banks in India, SBI, HDFC, Kotak, PNB. These are those large houses deep in the city with the most robust structures. Despite a disastrous 2017–18, PNB is still afloat(Nirav Modi defrauded the bank of ~INR 115 bn). Look at the number of deposits of HDFC Bank, INR 11,475 bn, against the advances of INR 9,937 bn. There is a cover of ~INR 1,500 bn to support any deposit withdrawal like it happened in Yes Bank and RBL and IndusInd. Yes Bank saw a withdrawal of ~INR 720 bn, IndusInd 11% and RBL 8% (Withdrawal value in each case of RBL and IndusInd was less than 250 bn but I don’t have the verified numbers to use here). In value and in percentage terms, HDFC has more than sufficient room for any fall in deposit which resulted in the big downfall of all the big private sector banks and i have a theory that all these withdrawals from these private bank would have gone to either one of SBI, PNB, Bank of Baroda or HDFC given their stature. I picked this data point for comparison to share price downfall as for all these banks, it hasn’t been their NPA figures ot Profit After Tax figures which have resulted in equity value erosion for them. One more factor which results in a huge equity erosion for a bank is alleged Fraud and that by the looks of it doesn’t seem emergent on the horizon for HDFC atleast. The third point (and second data point) that I need to discuss is the expectation around next year’s revenue or profit. As of March 31st 2020, RBL, IndusInd and Yes have more advances than deposits (they have given more loans in rupee terms than they have bank deposits in savings accounts, current accounts and fixed deposits) so for them to grow their loan book (so that they can earn interest income) they would either need to grow their deposits at a similar pace at which they give out loans or borrow to lend. I don’t expect their deposits to outgrow their advances anytime sooner given the recent turmoil in these banks. When banks borrow to lend, the cost tends to be higher (you can refer to any text on google to get a better understanding of this). This will reduce their profit margins (also called net interest income which is the difference between the rate at which you borrow and the rate at which you lend in lay man terms). Given their restriction to borrow and the associated costs, some share of their market of loans will go to banks which can offer better interest rates and are willingly to give loans. In Pvt sector, only 2 big fishes remain, HDFC and Kotak. Even Kotak has limited buffer between its deposit surplus over its advances (INR 200 bn against HDFC’s INR 1,500 bn). Again in very simple terms, HDFC can use part of its INR 1,500 bn (as long as it meets other compliance’s) to lend at no additional cost in this financial year and considering a modest simple interest of 9% p.a it can charge on say even INR 300–400 bn, it will generate an incremental income of INR 25–35 bn. Add that to the existing revenue of INR 1,148 bn as on March 31st, 2020, it will result in a revenue growth of 2–3%. Considering the bad loans might increase this year and there would be a loss of interest income on those for next year, it will result in a loss of revenue by INR 14–15 bn (HDFC has predicted bad loans to be INR 120 bn in this year, assuming they fetch interest income of 12% as they might be more risky hence higher probability of them going bad and hence higher interest rate would have been charged, the annual interest income from them would be INR 14-15 bn). So the net increase in revenue next year with this calculation would be INR 15–20 bn resulting in a growth of 1–2%. Given the levels at which it was trading in March 2020, before the lockdown, a 1–1 correlation suggests that the stock price should also increase by 1–2% (in March 2021) of its levels in March 2020 so it is expected to erase its 35% losses in equity share price and come back to pre lockdown price by end of March 2021 on a very conservative basis. Or maybe, all hell breaks loose and all investors of HDFC end up sitting on piles of pennies! Let’s wait and watch!

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