HDFC Bank falls out of analysts' favour as merger math spoils margin outlook

The stock of HDFC Bank slipped 9 percent in three months as against 2 percent drop in the Bank Nifty index

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The Street has turned cautious on shares of HDFC Bank after the lender’s July-September quarter (Q2FY24) scorecard revealed margin concerns post-merger with erstwhile HDFC and fall in earnings per share (EPS) growth for the period.

As per Moneycontrol’s Analyst Call Tracker for October, analysts did not share maximum optimism with the India’s largest private sector lender. HDFC Bank used to consistently feature among Street’s top 10 favourite picks in the previous months (see table).

Other lenders like ICICI Bank, Axis Bank, IndusInd Bank, and State Bank of India, however, continued to dominate analysts’ mind in October.

So, why are analysts growing conservative over HDFC Bank?

Bleak margin outlook

Nuvama Institutional Equities, for instance, believes that there is near-term uncertainty on the banks’ margin trajectory and their ability to deliver consistent deposit growth every quarter.

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In Q2FY24, HDFC Bank’s net interest margins (NIMs) contracted to 3.4 percent due to merger management and regulatory impact caused by incremental cash reserve ratio (ICRR), which was 5-10 bps for the quarter.

The regulation on ICRR has now been withdrawn, which analysts believe should result in reversing trend from Q3FY24. However, the normalisation of NIM at 3.65 percent is unlikely in the next one or two quarters and may take longer due to high cost of erstwhile HDFC borrowings and loan-to-deposit ratio.

Thus, given margin pressures and lower benefit of cost ratios, analysts at Axis Securities trimmed earnings estimates for HDFC Bank by 2-5 percent over FY24-26E.

Asset quality impacted slightly post amalgamation

HDFC Bank’s gross non-performing loan (NPL) ratio and net NPL ratio saw sequential increase of 10 bps and 20 bps, respectively in the September-ended quarter. This was mainly on account of some slippages in the non-individual loan book from erstwhile HDFC.

The NPLs of combined HDFC and HDFC Bank was Rs 12,500 crore in Q2FY24, higher than Rs 8,950 crore in the year-ago period.

However, the bank has maintained a healthy provisioning coverage ratio (PCR) at 74 percent that would provide comfort in the long-term.

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PCR is the percentage of funds that a bank sets aside for losses due to bad debts. A high PCR can prove to be beneficial to banks to buffer themselves against losses if NPAs start to increase at a faster rate. As per RBI guidelines, PCR above 70 percent is considered to be healthy.

The double fall of stock price and EPS

The EPS growth of HDFC Bank fell significantly to 10.8 percent year-on-year (YoY) in Q2FY24 as compared to 20 percent growth seen in the previous quarter.

This fall in EPS growth was reflective on bourses as well. The stock of HDFC Bank slipped 9 percent in three months as against 2 percent drop in the Bank Nifty index.

The sharp correction, analysts said, was first majorly due to uncertainty around the merger and later due to merger math being weaker than initial estimates.

Way forward

That said, analysts at Kotak Institutional Equities assume the worst of merger-related news flow would be worked through and the bank may be able to grow with fewer concerns hereon. They expect HDFC Bank’s balance sheet to grow at a marginally faster rate than industry average.

“We maintain ‘buy’ rating for HDFC Bank with target price of Rs 1,800 per share. At our target price, we value the bank 2.6 times (x) book and 17x 2025E EPS for return of equities (ROEs) at 16 percent levels and 15 percent compounded annual growth rate (CAGR),” the brokerage firm added.

Those at Nuvama believe that a gradual re-rating for HDFC Bank would depend on how consistent the bank is delivering loan and deposit growth. The management is confident of delivering strong and granular loan and deposit growth.

Meanwhile, analysts at Motilal Oswal said that the bank posed a good beginning post-merger but still has a long way to go. “We estimate HDFC Bank to deliver a CAGR of 18/20 percent in loans/deposits and 21 percent CAGR in earnings over FY24-26, translating into RoA/RoE of 2/17.4 percent by FY26E,” they wrote in a post-result review note.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.