2. 2
Index:
Introduction and Company Analysis :
Company Background
Key Products and Services
Current Status
Banking in India: An Industry Overview:
A Brief History
The Indian Banking Structure
Current Status and Reputation
Industry Analysis using Porter’s 5 Forces Model
Macro-Economic Analysis of India’s Banking Sector:
Brief Introduction
Global macroeconomic outlook
Global Capital Flows
Indian Outlook
Primary sector
Secondary sector
Price
Tertiary Sector
Inflation
EXIM
Indian Economy an overview
3. 3
Introduction
Market size
Investments/ Developments
Government Initiatives
Road Ahead
Ratio Analysis:
Introduction
Assumptions
Ratios
Performance Ratios
Profitability Ratios
Liquidity Ratios
Management Efficiency Ratios
Debt Coverage Ratios
Cash Flow Analysis:
Free Cash Flow to Equity (FCFE)
FCFF vs FCFE
Enterprise Value
Enterprise Value as an Enterprise Multiple
Equity Value V. Enterprise Value
Economic Value Added
Market Value Added
Intrinsic Value
Breaking Down 'Intrinsic Value’
Assumptions
Investment Rationale:
Falling Gross NPA’s
4. 4
Industry Outperformance
Favourable Numbers
Steady growth in Earnings per share and Dividend per share
Macro-Economic Investment Rationale
Tapering interest rates
Huge latent demand for banking in India
Positive Economic and Demographic Factors
Increasing demand for personal loans
Infrastructure support
Conducive policy framework
Risk Scenario:
Credit Risks
Concentration Risks
Liquidity Risks
Price Risks
Exchange Rate Risks
Derivatives Risks
Operational Risks
Valuation Ratios:
Conclusion
Annexure
References
Charts:
Chart 1. Screenshot from IBEF.org
Chart 2. Inflation
Chart 3. Dividend Per Share
Chart 4. Earnings Per Share (EPS)
Chart 5. GDP/Loan
5. 5
Chart 6. BankingPenetration
Chart 7. Loan Growth Forecast
Chart 8. Growth in Personal Loans
Chart 9. Growth in HousingLoans
Chart 10. Gross and Net NPAs
Chart 11. Bifurcation of Deposits
Figures:
Figure 1. Framework of Scheduled Banks in India
Figure 2. Porter’s 5 Forces Model
Figure 3. Types of Ratios
Figure 4. Enterprise Value
Figure 5. Valuation Ratios of 5 Banks
7. 7
HDFC Bank Limited:
1. Introduction and Company Analysis:
1.1 Company Background:
With a market capitalisation of about Rs. 2,73,425 crores as on October 9th, 2015,
the Housing Development Finance Corporation (HDFC) Ltd, is India’s 5th largest
bank in terms of assets. Headquartered in Mumbai-Maharashtra, HDFC has
consistently been ranked as one of the top and most trusted banks in India, even
earning a position in the list of top 50 banks in the world.
Incorporated in 1994 and backed by a leading housing finance corporation, the
Housing Development Corporation, HDFC Bank ltd. officially commenced its
operations in January 1995, from Mumbai. Today, the bank has a network of over
1415 branches spread across India linked through an online real-time basis. The
bank has also successfully established over 3,380 ATMs across 550 cities in the
country. Shares of HDFC are listed on various exchanges including BSE and NSE.
Its ADRs (American Depository Receipts) are listed on NYSE (New York Stock
Exchange) as HDB.
Other than a particular money-laundering allegation in 2013 (which lacked
evidence), HDFC has had a fairly good run with no major controversies or
outbreaks with its customers or with the media. On 23rd May 2008, HDFC
formally acquired the Centurion Bank of Punjab by the approval of the RBI to
magnify its presence in Western India.
1.2 Key Products and Services:
Other than regular deposit and loan facilities, HDFC has a plethora of products
and services that are offered, oftentimes complex ones. The following is a list of
the key products and services that contribute maximum to the bank’s revenue:
NRI Banking: These including regular NRI financial services such as
money transfers, deposits, insurance, international payment services, etc.
Wholesale Banking: HDFC offers Wholesale Banking for Corporates and
Financial Institutions & Trusts. The bank also provides services such as
Investment Banking and other services in the Government sector.
Retail Banking Services: Being the very first bank in India to launch an
international Debit Card system with VISA, the bank today has diverged
into what has become the most profitable credit card business with a base
of about 19.74 million. HDFC is also one of the leading players in the
8. 8
merchant acquiring business-processing debit and credit card payments
on behalf of merchants.
Treasury: The bank’s treasury department handles all aspects of 3 main
areas: Equities, FOREX and Derivatives and Money Market and Debt
Securities. All risk and return strategies for this portfolio management are
handled by it.
1.3 Current Status:
Early this month, HDFC launched a nation-wide campaign aiming to now
position itself as a premier digital bank, following the footsteps of Prime Minister
Modi’s Digital India. A shedload of initiatives have been taken by HDFC to launch
itself into the digital world, with introduction of its PayZapp – a payment solution
gateway through cell phones. The company has so far been somewhat successful
in this campaign – having about 63% of all its transactions through digital
channels in the fiscal year 2014-2015.
As of 30th September 2013, the 2 major shareholders of HDFC Bank were its
Holding Company, the HDFC Group, and FIIs with 22.72% and 33.61% holdings,
respectively. The company has employed over 70,000 workers.
As of 31st March, 2013 the bank had assets worth Rs. 4.1 trillion and a reported
Net Profit of Rs. 69 billion – a 31% increase from the preceding year. The bank’s
customer base stood at about 30 million as on that date.
2. Banking in India: An Industry Overview:
2.1 A Brief History:
Banking in India dates back to the 18th century. The very first organised banks in
India date back to the 1770s when the Bank of Hindustan was formed. Although
these early-day banks eventually ended up liquidating themselves, they set up a
pathway for the Indian organised banking sector.
The largest bank in existence in India today – the State Bank of India started off
in 1806 as the Bank of Calcutta. 2 other banks, namely the Bank of Madras and
the Bank of Mumbai were subsequently formed under the presidency
government and these 3 banks merged to form the Imperial Bank of India in
1921 which finally, upon gaining independence, became SBI – as it is known
today.
Lastly, we talk of our central bank – the Reserve Bank of India. RBI was formed in
1934 and commenced its operations in 1935 under the British rule in accordance
to the provisions of the RBI Act of 1934. Its original share capital was entirely
owned by private shareholders. However, after independence, the RBI was
nationalised.
9. 9
2.2.1 The Indian Banking Structure:
Broadly speaking, the banking sector in India is divided into 2 categories:
Scheduled Banks: These banks are the ones that are regulated by the RBI
and have their respective paid up capital and reserves as per the RBI Act
of 1934. Essentially, almost all major commercial and regional banks in
India are scheduled banks and are therefore, eligible for loans from the
RBI at the going bank rate.
Non-Scheduled Banks: These banks are the ones that are not regulated by
the RBI or governed by the provisions of the RBI Act, 1934. There are only
4 commercial non-scheduled banks in the country.
The Scheduled Banks in India are officially classified into 5 groups:
Nationalised Banks: These banks are those whose ownership status was
changed from private to state owned. A majority of private banks that
were established during the British rule were nationalised in the first
phase in 1969 by Indira Gandhi – the then Prime Minister of India. The
first phase of nationalisation was followed by another round of
nationalisation in 1980.
SBI and its Associates: Initially the SBI had 8 associate banks which have
now come down to 5
Regional Rural Banks (RRBs): These are the local level banks that serve
the masses that live in rural India. The objective was to provide credit to
small and marginal farmers, agricultural labourers, artisans and small
entrepreneurs so as to develop productive activities in the rural areas.
Foreign Banks: These are banks that are headquartered abroadbut have
branches established in India. The aim of allowing them to enter the
country was to keep the pace of the banking sector as well as promote a
healthy level of competition in the banking sector.
Other Indian Private Sector Banks: These are banks that do not fall under
the ambit of the aforementioned 4 categories, but are still governed by
provisions of the RBI Act, 1934.
10. 10
Figure 1. Framework of Scheduled Banks, India
All such Scheduled Banks are answerable to the RBI, which is the apex of the
banking system in India. RBI is essentially autonomous, with little pressure from
the government. Although extremely complex, the Indian Banking sector is
widely renowned and is considered to be one of the most sophisticated systems
in the world. In terms of quality of assets and capital adequacy, Indian banks are
considered to have clean, strong and transparent balance sheets relative to other
banks in comparable economies in the region.
2.3Current Status and Reputation:
Chart 1. Screenshot from IBEF.org
11. 11
With the potential of becoming the 3rd largest banking industry in the world by
2025 according to a KPMG-CII report, the Indian banking industry is collectively
worth about $1.31 trillion.
India’s banking sector is sufficiently capitalised and regulated. Credit, markets
and liquidity risks have so far suggested that Indian banks have withstood global
death-waves pretty well.
The banking industry has done particularly well in the last couple of years. One
of the reasons for this was our Prime Minister, Mr. Modi. Pradhan Mantri Jan
Dhan Yojana – a scheme launched by our Prime Minister has been responsible
for the opening of more than 175 million bank accounts, nationwide as of August,
2015. Not only this, there have been quite a few developments in the recent past
that have triggered this kind of growth in our banking sector. Following are some
highlights of the same:
RBI’s approval for the establishments of 11 payment banks by applicants
has been quite the hot potato lately. These banks however, will not be
allowed to extend loans.
The RBI has allowed bonds issued by various MFIs such as the World
Bank, as eligible securities to facilitate interbank borrowing.
Alternative Investment Funds have been allowed by RBI to invest abroad
to increase investment opportunities.
The RBI, as and when needed, has carried out changes in monetary
policies. Quite recently, it dropped the repo rate by 50 basis points to
6.75% thereby stimulating demand in the country.
All this and more has managed leading credit agencies to change their ratings of
India, including Standard and Poor’s that estimated credit growth to improve by
12%-13% in FY 2016.
2.4 Industry Analysis using Porter’s 5 Forces Model:
Michael E. Porter’s 5 forces model is a framework established by a Harvard
University Professor that analyses the level of competition in an industry as
well as other aspects of an industry such as business strategy development.
The analysis tells one whether a particular industry is attractive or not.
12. 12
Figure 2. Porter's 5 Forces Model
The following is an analysis of the Indian Banking Sector, using the above
framework:
Threat of New Entrants: The threat of new entrants in the Indian
Banking Sector is a balanced game of weight. Essentially, if one has
sufficient capital, banking and investment knowledge, protected
intellectual property, etc. one can theoretically open up a Bank in
India. However, this is offset by the fact that every proposal for a
new Bank has to be approved by the RBI after following its
stringent norms, which are governed by the RBI Act, 1934. A
Government licensing is also required for the same. To sum up,
therefore, the threat of new entrants in the industry is moderately
high.
Bargaining Power of Buyers: Buyers here, tend to refer to a bank’s
customers. Their bargaining power in this industry is quite high
because of many reasons. Customers have access to all knowledge
required online, Switching cost from one bank to another is low,
different banks provide different combinations of products and
service and therefore the customer can choose whichever fits
his/her needs – all this has made the bargaining power of banking
customers high.
Bargaining Power of Suppliers: The suppliers, in this case the
banks, have a relatively low bargaining power. This is dude to the
fact that every bank has to abide by the stringent norms of the RBI.
The RBI requires every bank to have a certain percentage of their
funds as CRR (4% as of September, 2015), SLR (21.5%, as of
September, 2015), etc.
13. 13
Threat of Substitute Products or Services: Here too, the threat of
substitute products is high. Various banks offer a plethora of
different products and services with different risk and return
rates, liquidity options, tenures, etc. and therefore the threat of
substitutes is virtually constant. T-bills, securities and services
offered by NBFCs, Mutual Funds, etc. all are a part of this plethora
of products offered by the industry.
Intensity of Competitive Rivalry: In India, there are a total of 170
Scheduled Commercial Banks, including 91 RRBs, 19 nationalised
banks, SBI and its 5 associates, IDBI, etc. as well as 4 Non-
Scheduled Banks. This makes the level of competition in the
industry quite high. Other than this high number of players in the
sector, low growth rates, product differentiation, similar
strategies, brand identity, etc. have all contributed to intensify the
level of rivalry in the sector.
3. Macro-Economic Analysis of India’s Banking Sector:
3.1 Brief Introduction:
India, as we all know, is the world’s biggest democracy with a population of over
1.2 billion individuals. This implies that growth opportunities for the country are
also tremendous.
3.1.1 Global Macro-Economic Outlook:
Post the second quarter, global growth has slowed down especially in emerging
economies and global trade has shrunk increasing downside risks to growth.
Industrial production in developed economies like the United States and the
Euro zone has moderated. The US exports have shrunk on the back of a strong
dollar impacting the export driven economies negatively. However the consumer
demand showed some resilience as the labour market conditions improved. In
the Eurozone, a fragile recovery gained momentum on the supported by an ultra-
accommodative monetary policy. Economic activity in Japan as well is subdued
because of weak private consumption and exports. Emerging markets are
trapped in a vortex of weak global trade and commodity prices. China’s intended
shift from investment towards consumption is hindered by slower industrial
production, weaker exports and a stock market meltdown. The devaluation of
Renminbi has shaken the global financial markets. Brazil and Russia are
grappling with recession and are having difficulty in managing inflation, while
South Africa is facing structural constraints which might convert into a
downturn.
3.1.2 Global Capital Flows:
14. 14
Since the Chinese devaluation equity prices, commodities and currencies have
taken a hit as major funds have taken a safe flight back home from EMEs to more
mature bond markets. Although volatility cooled down in early September and
capital flows returned to EMEs, the sentiments still remained indecisive, though
the September federal policy decision to hold back the interest rates by the
Federal Reserve managed to lift the financial markets briefly the global
sentiments are still to stabilize.
3.2 Indian Outlook:
3.2.1 Primary sector: In India too, a fragile recovery is underway, affected
negatively by a 14% deficient southwest monsoon, though estimates show that
the food grain production would be higher than last years, reflecting timely
actions taken to contain adverse effects of rainfall deficiency. rural demand
however remained subdued as reflected in the shrinking two wheeler and
tractor sales.
3.2.2 Secondary sector :
Manufacturing sector showed signs of uneven growth in april-july with growth
slowing down in july. Although it has been in expansionary mode for the ninth
month consecutively, Industries such as apparels furniture and motor vehicles
have shown signs of growth, the growth in consumer durables is indicative of
some pick up in consumption, primarily in urban areas, however external
demand conditions have weakened owing to a global over supply leading to
increasing domestic capacity under utilisation and increasing level of
inventories. The under realisation of export goods is also putting stress on
export oriented firms balance sheets.
3.2.3 Price:
as a result of weak aggregate demand, the price growth remained weak,
however, on the back of falling commodity prices, raw material costs for most
producers went down. The reducing raw material costs were offset by lower
realisation costs and depleted margins as investment intentions remained
subdued.
3.2.4 Tertiary Sector:
In services, IT sector remained flat despite weak global demand as the rupee
weakened through the first two quarters, Rupee is expected to strengthen going
forward and settle at levels of 61.3 by year end, indicating higher import costs
for IT outsourcing firms in the US and elsewhere, The construction sector
continued to remain weak reflected by low demand for cement and large unsold
inventory for houses. Public infrastructure spending on roads, ports and
railways might however, give some essential lift to this sector, the services PMI
15. 15
expanded for the second month in a row, but the business sentiment continued
to remain low.
3.2.5 Inflation:
CPI inflation reached its lowest level in august, since november 2014 owing
largely to favourable base and low month on month increase in prices, cereal
inflation also moderated but price pressures on pulses and onions remained
elevated. CPI inflation excluding food and fuel eased in august for the second
month in a row due to the falling petrol and diesel prices giving a downward
momentum to inflation in transportation. Inflation in housing increased but was
more than offset by moderation in a basket of other lifestyle services like
education, personal care and health.
Chart 2. Inflation
3.2.6 EXIM:
With the weakening growth in EMEs and the worlds trade volume growth falling below
worlds GDP growth rate, India’s merchandise exports continued their fall in the first
two months of Q2. Value of imports also declined, but the sharp fall in crude oil and gold
prices was offset by rising import volumes. Non-oil and non-gold imports went back
into contraction after recording a marginal rise in the previous quarter, although there
were higher imports of fertilisers, electronics and pulses. With services exports
moderating, the widening of the merchandise trade deficit could lead to a modest
increase in the current account deficit (CAD) during Q2. Net capital inflows were
buoyed by sustained foreign direct investment and accretion to non-resident deposits,
and reduced by portfolio outflows, mainly from equity markets. Foreign exchange
reserves rose by US $ 10.4 billlion during the first half of 2015-16.
16. 16
3.3 Indian Economy an Overview:
3.3.1 Introduction:
India is expected to emerge as the world’s fastest-growing economy by 2015 ahead of
China, as per a report by The World Bank. India’s Gross Domestic Product (GDP) is
expected to grow at 7.5 per cent in FY 2015-16.
The improvement in India’s economic fundamentals has gathered pace in the year 2015
with the combined impact of strong government reforms, RBI's inflation focus
supported by falling global commodity prices.
3.3.2 Market size:
According to IMF World Economic Outlook April, 2015, India ranks seventh globally in
terms of GDP at current prices and is expected to grow at 7.5 per cent in 2016.
India’s economy has seen a rapid economic growth in the recent past, growing by 7.3
per cent in FY2015 against 6.9 per cent in FY2014. Indian economy is estimated to be at
Rs 129.57 trillion (US$ 2.01 trillion) for the year 2014 compared to Rs 118.23 trillion
(US$ 1.84 trillion) in 2013.
The steps taken by the government have shown positive results as India's gross
domestic product (GDP) at factor cost at constant (2011-12) prices 2014-15 is Rs 106.4
trillion (US$ 1.596 trillion), against Rs 99.21 trillion (US$ 1.488 trillion) in 2013-14,
posting a growth rate of 7.3 per cent. The economic activities that saw significant
growth were ‘financing, insurance, real estate and business services’ at 11.5 per cent
and ‘trade, hotels, transport, communication services’ at 10.7 per cent.
According to a Goldman Sachs report released in September 2015, India could grow at 8
per cent on average during from fiscal 2016 to 2020 driven by greater access to
banking, technology adoption, urbanization and other structural reforms.
3.3.3 Investments/Developments:
With the improvement in the economic scenario, there have been various investments
leading to increased M&A’s. Some of them are as follows:
India has emerged as one of the strongest performers in terms of deals across the world
with respect to mergers and acquisitions (M&A). M&A activity increased in 2014 with
deals worth US$ 38.1 billion being sealed, compared to US$ 28.2 billion in 2013 and US$
35.4 billion in 2012. The total transaction value for the month of July 2015 was US$ 6.7
billion involving a total of 156 transactions, which were higher in terms of volume (47
per cent) and value (17 per cent) compared with the same period last year. In the M&A
space, Energy and natural resources was the dominant sector, amounting to 38 per cent
of the total transaction value. Also, Private equity (PE) investments increased 16 per
cent y-o-y to US$ 2.2 billion, marking the highest activity in 2015.
India’s Index of Industrial Production (IIP) grew by 4.2 per cent in July 2015
compared to 3.8 per cent in June 2015. The growth was largely due to the boost
17. 17
in Electricity sector growth, which was 3.5 per cent in July compared to 1.3 per
cent in the previous month.
India’s Consumer Price Index (CPI) inflation rate eased to 3.66 per cent in August
2015 compared to 3.69 per cent in the previous month. On the other hand, the
Wholesale Price Index (WPI) inflation rate remained negative at 4.95 per cent for
the tenth consecutive month in August 2015 as against negative 4.05 per cent in
the previous month, led by low crude oil prices.
India's consumer confidence continues to remain highest globally for the fifth
quarter in a row, riding on positive economic environment and lower inflation.
According to Nielsen’s findings, India’s consumer confidence score in the second
quarter of 2015 increased by one point from the previous quarter (Q1 of 2015).
With a score of 131 in the second quarter (2015), India's consumer confidence
score is up by three points from the corresponding period of the previous year
(Q2 of 2014) when it stood at 128.
India’s current account deficit reduced sharply to US$ 1.3 billion (0.2 per cent of
GDP) in the fourth quarter of 2015 compared to US$ 8.3 billion (1.6 per cent of
GDP) in the previous quarter, indicating a shrink in the current account deficit by
84.3 per cent quarter-on-quarter basis.
India's foreign exchange reserve stood at a high of US$ 352 billion in the week up
to September 18, 2015 – indicating an increase of US$ 631.5 million compared to
previous week.
Owing to increased investor confidence, net Foreign Direct Investment (FDI)
inflows touched a record high of US$ 34.9 billion in 2015 compared to US$ 21.6
billion in the previous fiscal year, according to a Nomura report. The report
indicated that the net FDI inflows reached to 1.7 per cent of the GDP in 2015
from 1.1 per cent in the previous fiscal year.
3.3.4 Government Initiatives:
Numerous foreign companies are setting up their facilities in India on account of
various government initiatives like Make in India and Digital India. Mr. Narendra Modi,
Prime Minister of India, has launched the Make in India initiative with an aim to boost
the manufacturing sector of Indian economy. This initiative is expected to increase the
purchasing power of an average Indian consumer, which would further boost demand,
and hence spur development, in addition to benefiting investors. Besides, the
Government has also come up with Digital India initiative, which focuses on three core
components: creation of digital infrastructure, delivering services digitally and to
increase the digital literacy. Finance Minister Mr Arun Jaitley stated that the
government is looking at a number of reforms and resolution of pending tax disputes to
attract investments.
Currently, the manufacturing sector in India contributes over 15 per cent of the GDP.
The Government of India, under the Make in India initiative, is trying to give boost to
the contribution made by the manufacturing sector and aims to take it up to 25 per cent
of the GDP. Following the government’s initiatives several plans for investment have
been undertaken which are as follows:
Foxconn Technology group, Taiwan’s electronics manufacturer, is planning to
manufacture Apple iPhones in India. Besides, Foxconn aims to establish 10-12
facilities in India including data centers and factories by 2020.
18. 18
US-based First Solar Inc and China’s Trina Solar have plans to set up
manufacturing facilities in India. Clean energy investments in India increased to
US$ 7.9 billion in 2014, helping the country maintain its position as the seventh
largest clean energy investor in the world.
Hyderabad is set to become the mobile phone manufacturing hub in India and is
expected to create 150,000 – 200,000 jobs. Besides, the Telangana Government
aims to double IT exports to Rs 1.2 trillion (US$ 18.7 billion) by 2019.
General Motors plans to invest US$1 billion in India by 2020, mainly to increase
the capacity at the Talegaon plant in Maharashtra from 130,000 units a year to
220,000 by 2025.
Hyundai Heavy Industries (HHI) and Hindustan Shipyard Ltd have joined hands
to build warships in India. Besides, Samsung Heavy Industries and Kochi
Shipyard will be making Liquefied Natural Gas (LNG) tankers.
JSW Group plans to expand its cement production capacity to 30 MTPA from 5
MTPA by setting up grinding units closer to its steel plants.
Under the Digital India initiative numerous steps have been taken by the
Government of India. Some of them are as follows:
The Government of India has launched a digital employment exchange which will
allow the industrial enterprises to find suitable workers and the job-seekers to
find employment. The core purpose of the initiative is to strengthen the
communication between the stakeholders and to improve the efficiencies in
service delivery in the MSME ministry. According to officials at the MSME
ministry over 200,000 people have so far registered on the website.
The Ministry of Human Resource Development recently launched Kendriya
Vidyalaya Sangthan’s (KVS) e-initiative ‘KV ShaalaDarpan’ aimed at providing
information about students electronically on a single platform. The program is a
step towards realising Digital India and will depict good governance.
The Government of India announced that all the major tourist spots like Sarnath,
Bodhgaya and Taj Mahal will have a Wi-Fi facility as part of digital India
initiative. Besides, the Government has started providing free Wi-Fi service at
Varanasi ghats.
Based on the recommendations of the Foreign Investment Promotion Board (FIPB),
the Government of India has recently approved 23 proposals of FDI amounting to Rs
10,378.92 crore (US$ 1,567.75 million) approximately in August.
The Government of India has launched an initiative to create 100 smart cities as well
as Atal Mission for Rejuvenation and Urban Transformation (AMRUT) for 500 cities
with an outlay of Rs 48,000 crore (US$ 7.47 billion) and Rs 50,000 crore (US$ 7.78
billion) crore respectively. Smart cities are satellite towns of larger cities which will
consist of modern infrastructure and will be digitally connected. The program was
formally launched on June 25, 2015. The Phase I for Smart City Kochi (SCK) will be
built on a total area of 650,000 sq. ft., having a floor space greater than 100,000 sq.
ft. Besides, it will also generate a total of 6,000 direct jobs in the IT sector.
3.3.5 Road Ahead:
The International Monetary Fund (IMF) and the Moody’s Investors Service have
forecasted that India will witness a GDP growth rate of 7.5 per cent in 2016, due to
improved investor confidence, lower food prices and better policy reforms. Besides,
19. 19
according to mid-year update of United Nations World Economic Situation and
Prospects, India is expected to grow at 7.6 per cent in 2015 and at 7.7 per cent in
2016.
As per the latest Global Economic Prospects (GEP) report by World Bank, India is
leading The World Bank’s growth chart for major economies. The Bank believes
India to become the fastest growing major economy by 2015, growing at 7.5 per
cent.
According to Mr Jayant Sinha, Minister of State for Finance, Indian economy would
continue to grow at 7 to 9 per cent and would double in size to US$ 4–5 trillion in a
decade, becoming the third largest economy in absolute terms.
Furthermore, initiatives like Make in India and Digital India will play a vital role in
the driving the Indian economy.
4. Ratio Analysis:
4.1 Introduction:
In essence, financial statement analysis refers to the process of reviewing,
studying and eventually analysing a company’s financial statements (majorly the
Income Statements, Cash Flow Statements and the Balance Sheets) in order to
predict future trends and make economic and business decisions.
Conventionally, simply reading past data is never enough, which is why we need
the help of financial ratios. There is a tremendous number of aspects of a
company’s financial statements and therefore, each one of them needs to be
looked at individually to predict future trends and make decisions. Ratios,
therefore, help us do just that.
Now the traditional formulas of certain ratios have to be tweaked a bit to fit into
the banking industry. For example, there are no “sales” in banking per se, but the
“sales” of the manufacturing sector is said to be equivalent to “interest income”
in the banking sector. Therefore these few changes are made to these ratios such
that they make sense.
For HDFC, we have taken data for 2 years namely, FY 2013-2014 and FY 2014-
2015 and compared these 2 years on the basis of the following ratios in
retrospect. The data was picked up from MoneyControl.com and in turn,
analysed by us.
20. 20
Figure 3. Types of Ratios
4.2Assumptions:
The Banking Industry is essentially a part of the service sector and so the
conventional formulas applicable for manufacturing sectors do not apply here.
Therefore, while performing the calculations, we have tweaked the formulas a
bit with the help of the following assumptions:
Instead of “Net Sales” usually used in the manufacturing sector, we
have used “Net Interest Income” since that is the main source of
income for a bank.
The exact numbers have been picked up from MoneyControl.com
(Link in the Sources page).
4.3. Ratios:
4.3.1. Performance Ratios: These ratios tell us how efficiently does the firm
utilise its resources to generate sales and increase overall shareholder
value. Essentially, these ratios imply level of execution and conduct of
operations to make profits. The ratios we have used are:
Return on Capital Employed (RoCE) = Earnings Before Interest and Tax
(EBIT)/Capital Employed.
HDFC’s RoCE fell from 21.53% to 18.82% in FY 2014-15 indicating a fall in
profits, which could be due to various reasons. However, the RoCE was higher
than the bank’s WACC, which is 12.28% thus keeping the bank safe from
instability.
Return on Equity (RoE) = Net Income/Shareholder's Equity
21. 21
FY 2015 saw a fall in the RoE of HDFC from the preceding year’s 21.28% to
19.37%. This again, is an indicator of either falling net income, which is a
negative suggestion for a company or increasing equity, which has the same
effect.
Return on Assets (RoA) = Net Income/Total Assets
HDFC’s RoA remained from or less the same, falling just 1 basis point from the
preceding year.
Conclusion: HDFC should be worried about its returns indicated by falling
performance ratios. All of the above ratios have shown a falling trend from the
preceding year (2013-2014), which is a sign of unhealthy operations.
4.3.2. Profitability Ratios: These are self-explanatory in the sense that they
convey how well a company can convert its to net or operating profits.
The following are the ones we have used:
Net Profit Margin = Net Profit/Revenue
HDFC’s NP Margin has increased slightly from preceding year’s 20.61% to
21.07%. Although this is definitely a sign of good health, an increase by higher
percentage would make give the bank a more comfortable position, keeping
inflation in mind.
Return on Net Worth = Net Profit/Net Worth (Shareholder’s Equity + Retained
Earnings)
HDFC’s RoNW Ratio has declined from 19.5% to 16.47% in FY 2015. A falling
RoNW has a negative connotation attached to it.
Conclusion: Although the Net Profit of HDFC seems to be on a rise, this rise is
not enough. The debt levels should also be checked to understand the true colour
of these ratios. The same has been analysed ahead.
4.3.3. Liquidity Ratios: Liquidity ratios denote how capable a firm is to pay off
its obligations, both – long and short. Generally as a rule-of-thumb, the
higher this ratio, the higher is the margin of safety that implies the higher
ability of the firm to pay off its obligations as and when they arise. For this
report, we have taken the following:
Current Ratio = Current Assets/Current Liabilities
A higher current ratio is favourable, but not too high a number. The numbers (as
shown in the attached Excel Sheet) for the same of HDFC have shown a falling
trend from FY 2013 to FY 2014. This suggests a falling capability of HDFC to fulfil
its short-term obligations.
Quick Ratio = (Cash+Marketable Securities+Receivables)/Current Liabilities
22. 22
This ratio is a tighter squeeze to check whether a firm can pay off its short-term
liabilities. Fortunately for HDFC, a rising trend for this ratio can be seen from
8.55 to 12.69 in FY 2014-15.
4.3.4. Management Efficiency Ratios: These ratios are somewhat similar to
Activity Ratios in the sense that they measure and analyse how well a
company or firm uses its assets and liabilities internally. The most
common of these are turnover ratios, which have been depicted in the
attached Excel Sheet and analysed for HDFC as follows:
Loans Turnover Ratio = Net Interest Income/Average Total Loans
This ratio is specific to the banking industry and shows how much of income is
generated with respect to per unit of loan given out. Obviously, a higher number
is indicative of healthy management. HDFC’s LTR, however, has remained
unchanged from FY 2013 to FY 2014 at 0.15.
Asset Turnover Ratio = Net Interest Income/Average Total Assets
This ratio shows how efficiently the bank uses the assets under its disposal to
generate sales (interest, in the case of the banking industry). Obviously higher
the ratio the better, although very high ratios may suggest the need for an
increase in assets. HDFC’s ATR has remained unchanged at 0.1 from FY 2013 to
FY 2014.
Conclusion: Both the above ratios, in the case of HDFC, have remained the same
throughout the subject years. This suggests stagnancy and not growth and
therefore, is an issue that should be looked into by the bank.
4.3.5. Debt Coverage Ratios: The debt coverage ratio is used in banking to
determine a bank’s ability to generate enough income in its operations to
cover the expense of a debt. Essentially it shows the bank’s strength in
earning enough interest income to cover its debts (deposits).
Debt to Capital Ratio = Debt/(Shareholder’s Equity+Debt)
DCR is essentially the measure of a company’s leverage. Herein, debt refers to
both – short and long-term obligations. It measures how much of the capital
employed is debt. Higher debt included in the capital employed means higher
risk of insolvency (depends on the industry too). HDFC has shown a fall in this
ratio from 8.45% to 7.27% in FY 2014, which is suggestive of a lower debt
percentage as a portion of total capital.
Cash Deposit Ratio = Total of Cash in hand and Balances with RBI/Total
Deposits
The CDR is a measure of how much a bank lends out of the deposits it possesses.
In case of HDFC, there has just been a slight increase in this ratio from 6.02% to
23. 23
6.46% in FY 2014 from FY 2013. This is indicative of a higher amount of cash
balances and a lower amount of loans given out.
5. Cash Flow Analysis:
Free cash flow to the firm, or FCFF, measures money and time through the use of
short- and long-term assets and earnings before interest, taxes, depreciation and
amortization (EBITDA) in its calculations. FCFF itself is used to measure the risk an
investor faces in getting a return on his investment.
FCFF uses both short- and long-term investments in its calculations. This helps
capture the measurement of time. In addition, each component of the FCFF
equations is over a specific time period, so it is possible to calculate the monthly,
quarterly or yearly FCFF depending on the time frame the investor wants to use.
FCFF measures money through the use of financial information in each one of its
components. All types of earnings, from net income to EBITDA, measure the money a
company makes over the specified time period. All noncash charges including
interest and depreciation are added back to capture the actual cash flow of the
business. Since the money a company uses for investments cannot be paid out to
investors in the form of cash, these are subtracted from the equation.
Although FCFF is a monetary measure of how much money is available to investors,
it is a great indicator of risk. If the FCFF is low or negative, it could be a signal the
investment is not safe because there is either a low return or no return. A high
amount of FCFF could be a signal there is low risk and the investment is a good
opportunity.
5.1 Free Cash Flow to Equity (FCFE):
This is a measure of how much cash can be paid to the equity shareholders of the
company after all expenses, reinvestment and debt repayment.
Calculated as: FCFE = Net Income - Net Capital Expenditure - Change in
Net Working Capital + New Debt - Debt Repayment
Investors are keen to find the right set of metrics to evaluate the performance and likely
growth of a company. Free cash flow to equity (FCFE) is one of the many ways of
assessing company value. It is often used as an alternative to the dividend discount
model, as that model has proven to be difficult to apply in practice.
A useful FCFE depends on the initial free cash flow figures being accurate and
transparent. Although free cash flow (FCF) indicates very clearly how well a company
can service debts, invest in growth and weather minor economic fluctuations, the way
that it is calculated is subject to manipulation. Because FCF is an indicator of how
24. 24
money is being spent at the present time rather than capital investment, companies
seeking investment may underreport capital expenditure and R&D costs, neither of
which form part of FCF calculations. The methods by which receivables are recorded
can also be manipulated to boost apparent FCF.
These tricks can make it difficult to get an accurate read on a company's FCF without
performing extensive analysis. This can affect what FCFE calculations can tell an analyst.
Once a level of confidence in the FCF figures is reached, the FCFE helps to quantify the
likely returns for investors in that business.
The calculation is expressed as Net Income - Net Capital Expenditure - Change in Net
Working Capital + New Debt - Debt Repayment. This is then a relatively accurate
reflection of the money available to pay dividends to investors once reinvestment in the
business and development costs are taken into account, and hence a moderately reliable
company valuation for prospective investors.
While any such calculation is purely an indicator rather than a sure fire way of working
out the next big investment, knowing how to calculate FCFE can help avoid companies
that do not have sufficient resources left to grow into the future.
5.2 FCFF vs FCFE:
The two free cash flow approaches, indirect and direct, for valuing equity should
theoretically yield the same estimates if all inputs reflect identical assumptions. An
analyst may prefer to use one approach rather than the other, however, because of
the characteristics of the company being valued. For example, if the company’s
capital structure is relatively stable, using FCFE to value equity is more direct and
simpler than using FCFF. The FCFF model is often chosen, however, in two other
cases:
o A levered company with negative FCFE: In this case, working with FCFF to
value the company’s equity might be easiest. The analyst would discount
FCFF to fi nd the present value of operating assets (adding the value of
excess cash and marketable securities and of any other significant non
operating assets to get total firm value) and then subtract the market
value of debt to obtain an estimate of the intrinsic value of equity.
o A levered company with a changing capital structure: First, if historical
data are used to forecast free cash flow growth rates, FCFF growth might
reflect fundamentals more clearly than does FCFE growth, which reflects
fluctuating amounts of net borrowing. Second, in a forward-looking
context, the required return on equity might be expected to be more
sensitive to changes in financial leverage than changes in the WACC,
making the use of a constant discount rate difficult to justify.
5.3 Enterprise Value:
Enterprise Value, or EV for short, is a measure of a company's total value, often used as
a more comprehensive alternative to equity market capitalization. The market
capitalization of a company is simply its share price multiplied by the number of shares
a company has outstanding. Enterprise value is calculated as the market
25. 25
capitalization plus debt, minority interest and preferred shares, minus total cash
and cash equivalents. Often times, the minority interest and preferred equity is
effectively zero, although this need not be the case.
EV = market value of common stock + market value of preferred equity + market
value of debt + minority interest - cash and investments.
Enterprise value can be thought of as the theoretical takeover price if the company were
to be bought over. In the event of such a buyout, an acquirer would generally have to
take on the company's debt, but would pocket its cash for itself. EV differs significantly
from simple market capitalization in several ways, and many consider it to be a more
accurate representation of a firm's value.
The value of a firm's debt, for example, would need to be paid by the buyer when taking
over a company, thus enterprise value provides a much more accurate takeover
valuation because it includes debt in its value calculation.
5.3.1. Enterprise Value as an Enterprise Multiple:
Enterprise multiples that contain enterprise value relate the total value of a company as
reflected in the market value of its capital from all sources to a measure of operating
earnings generated, such as EBITDA.
EBITDA = Recurring Earnings from Continuing Operations + Interest + Taxes
+ Depreciation + Amortization
The Enterprise Value/EBITDA multiple is positively related to the growth rate in free
cash flow to the firm (FCFF) and negatively related to the firm's overall risk level
and weighted average cost of capital (WACC).
EV/EBITDA is useful in a number of situations:
The ratio may be more useful than the P/E ratio when comparing firms with
different degrees of financial leverage (DFL).
EBITDA is useful for valuing capital-intensive businesses with high levels
of depreciation and amortization.
EBITDA is usually positive even when Earnings Per Share (EPS) is not.
EV/EBITDA also has a number of drawbacks, however:
If working capital is growing, EBITDA will overstate cash flows from operations (CFO or
OCF). Further, this measure ignores how different revenue recognition policies can
affect a company's CFO.
What is Equity Value?
Equity Value is simply the Value of a firm’s equity i.e. the market Capitalization of the
Firm. It can be calculated by multiplying the market value per share by the total number
of shares outstanding.
For example, let’s assume Company A has the following characteristics:
26. 26
Based on the formula above, you can calculate Company A’s Equity value as follows:
$1,000,000 x 50 = $50,000,000
However, in most cases this is not an accurate reflection of a company’s true value.
Enterprise Value = Market value of operating assets
Equity Value = Market value of shareholders’ equity
Figure 4. Enterprise Value
~ Net Debt – Net debt is equal to total debt less cash and cash equivalents.
When calculating total debt, be sure you include both the long-term debt and the
current portion of long-term debt, or short-term debt. Any in-the-money (ITM)
convertible debt is treated as if converted to equity and is not considered debt.
When calculating cash and equivalents, you should include such balance sheet
items as Available for Sale Securities and Marketable Securities,
The market value of debt should be used in the calculation of enterprise value.
However, in practice you can usually use the book value of the debt.
Let us explain it with an example. Consider the same company A and an another
company B having the same market capitalization. We assume two scenarios, 1 and 2.
Calculate Enterprise Value for Scenario 1.
27. 27
Enterprise Value for Company A is Market Capitalization ($50 million) + Debt ($20
million) – Cash and Short-term investments ($0) = $70 million. EV for Company B is
Market Capitalization ($50 million) + Debt ($0) – Cash and Short-term investments ($0)
= $50 million.
While both companies have the same market capitalization, the better buy is Company
B, or the company with no debt.
Now, consider scenario 2
Calculate Enterprise Value for Scenario 2. EV for Company A is Market Capitalization
($50 million) + Debt ($0) – Cash and Short term investments ($5 million) = $45 million.
EV for Company B is Market Capitalization ($50 million) + Debt ($0) – Cash and Short-
term investments ($15 million) = $35 million.
5.4 Equity Value v. Enterprise Value
Equity Value
Express the value of shareholders’ claims
on the assets and cash flows of the
business
Reflects residual earnings after the
payment to creditors, minority
Enterprise Value (EV)
Cost of buying the right to the
whole of an enterprise’s core
cash flow
Includes all forms of capital –
equity, debt, preferred stock,
28. 28
While both companies have the same market capitalization and no debt, the better deal
is Company B as you would assume $15 million in cash upon purchase of the company.
5.5 Economic Value Added:
In corporate finance, Economic Value Added (EVA), is an estimate of a firm's economic
profit – being the value created in excess of the required return of
the company's investors (being shareholders and debt holders). Quite simply, EVA is the
profit earned by the firm less the cost of financing the firm's capital. The idea is that
value is created when the return on the firm's economic capital employed is greater
than the cost of that capital.
EVA is frequently also referred to as "economic profit", and provides a measurement of
a company's economic success (or failure) over a period of time. Such a metric is useful
for investors who wish to determine how well a company has produced value for its
investors, and it can be compared against the company's peers for a quick analysis of
how well the company is operating in its industry.
Economic profit can be calculated by taking a company's net after-tax operating profit
and subtracting from it the product of the company's invested capital multiplied by its
percentage cost of capital.
shareholders & other non-equity
claimants
minority interest
Advantages of Equity Value
More relevant to equity valuations
More reliable?
More familiar to investors
Advantages of Enterprise Value
Accounting policy differences
can be minimized
Avoid influence of capital
structure
Comprehensive
Enables to exclude non-core
assets
Easier to apply to cash flow
29. 29
5.6 Market Value Added:
Market value added (MVA, is simply the difference between the current total market
value of a company and the capital contributed by investors (including both
shareholders and bondholders). MVA is not a performance metric like EVA, but instead
is a wealth metric, measuring the level of value a company has accumulated over time.
As a company performs well over time, it will retain earnings. This will improve
the book value of the company's shares, and investors will likely bid up the prices of
those shares in expectation of future earnings, causing the company's market value to
rise. As this occurs, the difference between the company's market value and the capital
contributed by investors (its MVA) represents the excess price tag the market assigns to
the company as a result of it past operating successes.
If MVA is positive, the firm has added value. If it is negative, the firm has destroyed
value. The amount of value added needs to be greater than the firm's investors could
have achieved investing in the market portfolio, adjusted for the leverage (beta
coefficient) of the firm relative to the market.
The formula for MVA is:
where:
MVA is market value added
V is the market value of the firm, including the value of the firm's equity and debt
K is the capital invested in the firm.
5.7 Intrinsic Value:
Intrinsic value is:
1. The actual value of a company or an asset based on an underlying perception
of its true value including all aspects of the business, in terms of both
tangible and intangible factors. This value may or may not be the same as
the current market value. Value investors use a variety of analytical
techniques in order to estimate the intrinsic value of securities in hopes of
finding investments where the true value of the investment exceeds its
current market value.
2. For call options, this is the difference between the underlying stock's price
and the strike price. For put options, it is the difference between
the strike price and the underlying stock's price. In the case of both puts
and calls, if the respective difference value is negative, the intrinsic value
is given as zero.
30. 30
5.7.1. Breaking Down 'Intrinsic Value’:
1. For example, value investors that follow fundamental analysis look at both
qualitative (business model, governance, target market factors etc.) and
quantitative (ratios, financial statement analysis, etc.) aspects of a business to
see if the business is currently out of favor with the market and is really worth
much more than its current valuation.
2. Intrinsic value in options is the in-the-money portion of the option's premium.
For example, If a call options strike price is $15 and the underlying
stock's market price is at $25, then the intrinsic value of the call option is $10. An
option is usually never worth less than what an option holder can receive if the
option is exercised.
5.7.2. Assumptions:
1. Depreciation rate assumed is 22.84% which is the average depreciation for the
last 5 years.
Since depreciation is hard to calculate for a company, we have taken average
depericiation for the last 5 years
2. CAGR of the company is calculated on the basis of last 5 years
As we are forcasting for the next five years, CAGR of the company has been taken
by taking into accont only the last 5 years.
3. Operating cost is taken as a percentage of sales
Operating cost is increases as the sales increases. So operating cost will increase
at the rate of increase in sales
4. Rate of tax is 35%
Last year company paid tax at the rate of 35% so we have assumed that company
will pay 35% tax this year too.
5. Sales are growing at CAGR.
As the company is growing at the rate of CAGR, Sales will grow at the rate of
CAGR
6. WC is zero as banks do not have any working capital
An ordinary company's internal business cycle can be thought of as the
following:
1. Beginning with your cash or credit, make some product [inventory] or prepare to
provide some service
2. Find customers to buy number 1.
3. Ship the product or deliver the service [record revenue], usually with an
agreement to be paid later [terms of sale]
4. Collect the accounts due, resulting in cash
31. 31
A bank's business is borrowing and lending money [plus a few odd other related
things]. Thus, they don't have much of step 1. They do have step 2. Step 3 is called
lending and step 4 would be receiving the loans back plus interest.
However, banks use much more leverage than ordinary businesses, in part because
their fixed assets are small relative to the volume of their 'sales'.
So, a bank's financial statements, if you tried to organize them the way an ordinary
company's statements are organized, would be all out of proportion. Little plant and
equipment. No inventory. Huge accounts receivable but much of it not for years.
Now, the accepted definition of working capital is all assets likely to 'turn' within one
year less all liabilities due within one year.
How can you apply this to banking? Some of the amounts due on a single loan are
coming in this year and some aren't. You'd have to divide the accounts of individual
borrowers into short term and long term.
Similarly, some deposits will be draw out within one year and some won't. And you
don't know which
So, we conclude that the concept 'net working capital' for a bank does not apply and
should not be computed.
7. Growth rate of GDP 7.4%
In an recent report by RBI, our economy will grow by the rate 7.4%
8. Government bond rate is 8%
9. As per Reuters.com beta for HDFC Bank is 1.1
10. For FCFF operating income is used
11. For FCFE net income is used
12. Borrowing are growing at the rate of 12.5%
6. Investment Rationale:
6.1 Falling Gross NPA’s:
Despite the banking sector suffering from poor asset quality, as the corporate
balance sheets remained under stress for the preceding two years, HDFC Bank
has shown some resilience in terms of asset quality as its gross NPA’s fell to
0.93% vs 1.00% YoY in the fiscal year , a drop of 7 basis points, going ahead we
expect the asset quality to improve as the economic revival is gaining
momentum with the industrial numbers looking favourable, the corporate
balance sheets are expected to follow suite.
6.2 Industry Outperformance:
32. 32
According to RBI’s Data, the net additions to the basket of assets under stress
though was considerably high for the banking sector as a whole, the aggressive
private banking sector somewhat maintained its turf with the public sector
bearing the bulk of the brunt owing to its high exposure to the public policy and
schemes and poor quality of assets. Among this resilient private sector too, HDFC
has been able to outperform its peers with the net addition to its gross Non
performing assets at 28% in the financial year 14-15, while its peers axis bank
added 31% bad loans to its basket and Kotak and Yes bank added 39.74% and
85.47% YoY respectively.
6.3 Favourable Numbers:
Compared to the only other Giant in the sector ICICI bank, HDFC fared better in
terms of CASA growth with its CASA growing at 19.44% compared to ICICI’s 15%
growth in CASA, The banks Net NPAs were also far lower at 1.82% compared to
ICICI’s 3.78%, the efficiency of operations reflected in the growth pattern as well
with HDFC growing at 20.6% vs ICICI’s 10% recorded growth
6.4 Steady growth in Earnings per share and Dividend per share:
HDFC bank has shown a steady growth in its dividends paid out per share with a
CAGR of 17.46% over the past 10 years for dividends and a CAGR of 22.35 for
Earnings per share, the dividends and earnings continued to grow in this fiscal as
well, with dividends growing at 15.9% and earnings growing at 18.59% .
Chart 3. Dividend Per Share
33. 33
Chart 4. Earnings Per Share (EPS)
6.5 Macro-Economic Investment Rationale:
6.5.1 Tapering interest rates:
With inflation and crude oil prices in ranges of comfort, the RBI has already cut
the interest rates by 125 BPS points making the cost of borrowing cheaper for
the banks and enabling them to expand their credit base, trading economics
predicts the interest rates to taper down to 4% by 2020 signifying an increasing
demand for money and credit in the future and presenting banking as a lucrative
sector to invest in, with the market share expanding and costs going down.
6.5.2. Huge latent demand for banking in India:
Despite the privatisation of banks, the banking penetration in India is still
relatively low when compared to developed nations and developing nations
both, this can be seen through the low loans to GDP ratio which stands at a mere
62% which is relatively low when compared to other emerging economies.
34. 34
Chart 5. GDP/Loan
The low banking penetration is also evident from the branches per 1,00,000 adults ratio
which again, shows a high scope for expansion.
Chart 6. Banking Penetration
6.5.3. Positive Economic and Demographic Factors:
India is expected to grow at a CAGR of 6.8% through 2012-2017, this will lead to
an increase in per capita income and a rise in the number of people availing the
35. 35
services of banking, this coupled with the fact that India enjoys a positive
demographic dividend with the working age population expected to grow
strongly, the banking sector credit as a whole is expected to grow to 2.4 trillion
at a CAGR of 18.1%.
Chart 7. Loan Growth Forecast
6.5.4. Increasing demand for personal loans:
Though India doesn’t have the culture of credit based demand but the demand
for personal finance is rising owing to primarily two factors, the first being the
rise in per capita income which in turn leads to a rise in disposable income and
standards of living, this gives individuals, room for availing personal credit the
second factor being the rapid urbanisation, increasing popularity of nuclear
families and easily available home loans that have led to an increase in demand
for housing loans, housing and personal loans provide an effective cushion to the
volatile corporate loans, demand in the mid and low income segments for
housing loans exceeds supply by four folds, representing a huge scope for
expansion in a readily available market, housing finance has grown at a pace of
11.5% between FY 09-15 and personal finance has grown at a pace of 9.3%
between FY 09-15.
Chart 8. Growth in Personal Loans
36. 36
Chart 8. Growth in Housing Loans
6.5.5 Infrastructure support:
According to Nirmala Sitaraman, India needs to invest over 1 trillion USD in
infrastructure in the coming few years to realise its growth potential, much of
this investment is expected to come from bank lendings thereby increasing the
net advances of the banking sector.
6.5.6. Conducive policy framework:
Policy moves like extending interest subsidies to low cost home buyers, easing of
KYC norms, introduction of no frills bank accounts and Kisan credit cards to
increase rural penetration are all expected to have a positive effect on the Indian
Banking Sector.
7. Risk Scenario:
7.1 Credit Risks:
Credit default risk — The risk of loss arising from a debtor being unlikely
to pay its loan obligations in full or the debtor is more than 90 days past
due on any material credit obligation.
Though the economic headwinds that the economy saw in the past two
years, exposed the banks to considerable credit risk, as the corporate
balance sheets shrunk or were in red, HDFC bank managed to shelter
itself from this turmoil with the gross and net NPA’s always remaining
below 1%, with the onset of economic revival post the mandate of 2014
elections, the balance sheets showed signs of strength and the gross
NPA’s fell from .98% to .93% of the total assets.
37. 37
Chart 9. Gross and Net NPAs
7.2 Concentration Risk:
The risk associated with any single exposure or group of exposures with the potential to
produce large enough losses to threaten a bank's core operations. It may arise in the
form of single name concentration or industry concentration.
An effective cushion to the volatile corporate loans is retail lending to multiple small
unrelated entities, HDFC Bank seems to be strengthening this cushion by expanding its
basket of retail loans to over a 50% of the total advances, however HDFC bank faces a
different kind of risk, a deposit concentration risk, where a bulk of the deposits are held
by a few very high net worth individuals, In its latest filing with the US markets
authority Securities and Exchange Commission (SEC), HDFC Bank has said 14% of its
depositors account for 53% of total deposits for the year ended March 2013. These
well-heeled clients account for 71% of the private bank's retail deposit base.
These ultra high net worth individuals may pose a concentration risk to the bank in a
scenario where these high net worth are forced to with draw their money which might
lead the bank to face liquidity issues, thereby posing as a liquidity risk.
The deposit concentration risk extends further with the proportion of time deposits
over 55% of total deposits.
Chart 10. Bifurcation of Deposits
38. 38
7.3 Liquidity Risks:
The purpose of liquidity management is to ensure that firm has sufficient cash flow
to meet all financial commitments and to capitalize on opportunities for business
expansion. This includes a banks ability to meet deposit withdrawals either on
demand or at contractual maturity, to repay borrowings as they mature and to
make new loans and investments as opportunities arise.
HDFC Banks Liquidity is managed on a daily basis by the Treasury Group under the
direction of the Asset Liability Committee (ALCO). The Treasury Group is
responsible for ensuring that the bank has adequate liquidity, ensuring that the
banks funding mix is appropriate so as to avoid maturity mismatches and price and
reinvestment rate risk in case of a maturity gap, and monitoring local markets for
the adequacy of funding liquidity.
7.4 Price Risk:
Price risk is the risk arising from price fluctuations due to market factors, such as
changes in interest rates and exchange rates. Conventionally, A banks Treasury
Group is responsible for implementing the price risk management process within
the limits approved by the board of directors. At HDFC, the treasury measures
price risk through a three-stage process, the first part of which is to estimate the
sensitivity of the value of a position to changes in market factors to which the
business is exposed. The treasury then estimates the volatility of market factors.
Finally, they aggregate portfolio risk. Price risk is managed mainly by establishing
limits for the money market activities, foreign exchange activities, interest rate and
equities and derivatives activities, In addition, the bank also adheres to certain
limits prescribed by the Reserve bank of India.
7.5 Exchange rate risk:
The bank monitors and manages its exchange rate risk through a variety of limits
on its foreign exchange activities. The reserve Bank of India also limits the extent to
which it can deviate from a “near square” position at the end of the day (where
sales and purchases of each currency are matched). The bank has its own policies
set limits on maximum open positions in any currency during the course of the day
as well as on overnight positions. The bank also has gap limits that address the
matching of forward positions in various maturities and for different currencies. In
addition, the they also have to adhere to gap limits set by the Reserve Bank Of
39. 39
India, This limit is applied to all currencies. The bank also have stop-loss limits that
requires the banks traders to realize and restrict losses. They evaluate the risk on
currency everyday, using the Value at risk Model.
The bank imposes position limits on its trading portfolio of marketable securities.
These limits, which vary by tenor, restrict the holding of marketable securities of
all kinds depending the analysts expectations about the yield curve. They also
impose trading limits such as, value-at-risk and stop-loss limits.
7.6 Derivatives Risk:
This risk is managed by the fact that the bank does not enter into or maintain
unmatched positions with respect to non-rupee-based derivatives. Its proprietary
derivatives’ trading is primarily limited to rupee-based interest rate swaps and
rupee currency options. Here again, they impose trading limits, such as value-at-
risk and stop-loss limits.
The day-to-day monitoring and reporting of market risk and counterparty risk
limits is carried out independently by the treasury mid-office department. The
treasury mid-office department is independent of the treasury department and has
a reporting line to the head of credit and market risk.
7.7 Operational Risk:
Operational risk is defined as the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. Operational risk
management encompasses identification, assessment, review, control and
reporting of key operational risks.
Some of the key principles ingrained in the Bank’s business operations towards
effective operational risk management cover, inter-alia, segregation of functions,
strong management team with vast experience in diverse fields, well defined
processes, standard operating manuals and job cards, transaction verification and
authorization systems, distributed processing, staff training and an effective
internal audit process.
40. 40
8. Valuation Ratios:
The following table has been made according to the numbers picked up at
Capitaline.com.
8.1 Valuation Ratios:
CPS (Cash flow Per Share) = (Operating Cash Flow – Preferred
Dividends)/Common Shares Outstanding.
This share shows the PAT of a bank after adding back depreciation, which is
essentially the cash flow of the bank, on a per share basis. This is somewhat
similar to the EPS of a firm, but an EPS can be easily manipulated to appear
Equ
ity
Gr.
Bulk
Sale
s
NP Va
r
%
Di
v
BV CP
S
EP
S
Pric
e
Mkt.
cap
P/
C
P/
E
P/
B
V
Ax
is
Ba
nk
475 4,49
7.01
43,8
43.6
4
7,36
0.16
18.
00
23
0.0
0
18
7.9
0
31
.7
0
30
.0
0
490.
00
116,6
04.30
15
.4
0
16
.3
0
2.
61
ICI
CI
Ba
nk
503.
64
8,46
3.30
57,4
66.2
6
10,2
08.5
5
20.
00
40
0.0
0
24
6.3
0
41
.5
0
38
.9
0
1,08
6.00
273,4
25.40
26
.1
0
27
.9
0
4.
41
H
DF
C
Ba
nk
1,16
1.54
10,4
04.4
2
61,2
67.2
7
11,1
70.5
6
15.
00
25
0.0
0
13
8.5
0
19
.9
0
18
.8
0
286.
00
166,1
58.00
14
.4
0
15
.2
0
2.
06
Ko
ta
k
Ba
nk
915.
26
2,14
5.81
11,7
48.3
2
1,85
7.08
24.
00
18.
00
77.
70
11
.1
0
10
.1
0
657.
00
120,3
47.70
59
.1
0
65
.1
0
8.
46
Ye
s
Ba
nk
418.
97
627.
99
13,6
18.4
6
2,00
5.46
24.
00
90.
00
27
8.8
0
48
.1
0
46
.0
0
725.
00
30,38
3.36
15
.1
0
15
.8
0
2.
60
Figure 5. Valuation Ratios of 5 Banks
41. 41
somewhat more attractive to shareholders and potential investors and
therefore the CPS is more reliable. The cash flows of a bank are obviously
more difficult to be manipulated and therefore, many analysts consider the
CPS to be a more relaible value of a company’s strength.
As can be seen from the above table, HDFC’s CPS is considerably lower than
most of its rivals at Rs. 19.90. This may be a cause for worry, however, a
decision cannot be made on just the basis of this ratio. Other aspects of the
financial statements also need to be taken into consideration before coming
to a conclusion.
EPS (Earnings Per Share) = (Net Profit-Preference Dividends)/Average
Outstanding Shares
EPS is the most widely used financial ratio across the world. It essentially
shows the maximum earning that the company is capable of giving out, on a
per share basis. There are several kinds of EPS ratios such as Basic EPS,
Diluted EPS, etc., however, here we have used the Basic EPS.
Here too, HDFC’s EPS is considerably lower than most of its competitors
other than Kotak Bank, at Rs. 18.80 per share. This maybe due to a lot of
reasons such as stagnant Profits (as emphasised in the Ratio Analysis
portion of this report) or a large number of outstanding shares. This mater
too, should be looked into by HDFC.
PC Ratio (Price to Cash flow) = Share price/Cash flow Per Share
This ratio is indicative of a firm’s stock valuation. The ratio, whether good or
bad, cannot be decided solely upon the number. A low number may show
that the stock is currently undervalued, whereas a higher number shows
that the stock is overvalued and therefore should be used for short selling.
This ratio is especially used for valuing stocks that have positive cash flows
but arent profitable yet because of large non-cash charges.
HDFC’s PC Ratio for the current FY (as on 9th October, 2015) reads at 14.40,
standing again at the lowest in the table.
PE (Price Earnings) Ratio = Market Value per Share/EPS
This is another popular ratio used for valuing a company that measures a
company’s earnings and its current market price. Different variations of the
PE measure exist such as the lagging or the trailing PE Ratios. An ideal
number for the PE Ratio depends from industry to industry.
Here too, HDFC’s numbers are the lowest among its competitors, lying at Rs.
15.20.
P to BV (Price to Book Value) Ratio = Stock Price/Total Assets –
Intanglible Assets and
Liabilities
42. 42
This ratio is used to compare the market price of a share to its book value to
conclude whether to buy or sell the share. When the Book Value of the share
if greater than its Market Value, the share should be bought and a long
position should be secured. However, when the Market Value of the share is
greater than the Book Value, the share should be sold and a short position
should be secured.
For HDFC the PB ratio stands at 2.06 and is suggestive of a decent trend,
however, it is still much lower than most of its competitors.
MULTIPLE Definition Advantages Disadvantages Value
EV/Sales Enterprise
value / net
sales
Least
susceptible
to
accounting
differences
Remains
applicable
even when
earnings
are
negative or
highly
cyclical
A crude
measure
as sales
are rarely a
direct value
driver
2.22
EV/EBITDA Enterprise
value /
Earnings
before Interest,
Tax,
Depreciation &
Amortization.
Also excludes
movements in
non-cash
provisions and
exceptional
items
EBITDA is
a proxy for
free cash
flows
Probably
the most
popular of
the EV
based
multiples
Unaffected
by
depreciatio
n policy
Ignores
variations
in capital
expenditur
e and
depreciatio
n
Ignores
potential
value
creation
through tax
manageme
nt
11.53
EV/NOPLAT Enterprise
value / Net
Operating
Profit After
Adjusted Tax
NOPLAT
incorporate
s a number
of
adjustment
s to better
reflect
operating
NOPLAT
adjustment
s can be
complicate
d and are
not applied
consistentl
y by
17.74
43. 43
profitability different
analysts
EV/opFCF Enterprise
value /
Operating Free
Cash Flow
OpFCF is core
EBITDA less
estimated
normative
capital
expenditure
requirement
and estimated
normative
variation in
working capital
requirement
Better
allows for
differences
in capital
intensivene
ss
compared
to EBITDA
Less
susceptible
to
accounting
differences
than EBIT
Use of
estimates
allows for
smoothing
of irregular
real capital
expenditur
es
Introduces
additional
subjectivity
in
estimates
of capital
expenditur
e
19.99
EV/Invested
Capital
Enterprise
value
/ Invested
capital
Can be
useful
where
assets are
a core
driver of
earnings,
such as for
capital-
intensive
industries
Book
values for
tangible
assets are
stated at
historical
cost, which
is not a
reliable
indicator of
economic
value
Book value
for tangible
assets can
be
significantly
impacted
by
differences
in
accounting
policies
0.21
44. 44
9. Conclusion:
Housing Development Finance Corporation (HDFC) Ltd, is India’s 5th largest bank in
terms of assets. Headquartered in Mumbai-Maharashtra, HDFC has consistently been
ranked as one of the top and most trusted banks in India. It has a market capitalisation
of about Rs. 2,73,425 crores as on October 9th, 2015. The bank has a network of over
1415 branches and 3,380 ATMs across 550 cities in the country. HDFC bank is listed on
various exchanges including BSE and NSE. Its ADRs (American Depository Receipts) are
listed on NYSE (New York Stock Exchange) as HDB. The banks key products include NRI
Banking, Wholesale Banking, Retail Banking Services, and Treasury. Currently the bank
is concentrating on its nation-wide campaign which aims to position itself as a premier
digital bank, following the footsteps of Prime Minister Modi’s Digital India. Many new
initiatives have been taken up by HDFC to launch itself into the digital world, with
introduction of its PayZapp – a payment solution gateway through cell phones also
resulting having about 63% of all its transactions through digital channels in the fiscal
year 2014-2015.
As per the RBI Act of 1934 the Indian banking sector can be divided into two parts,
namely Scheduled banks and Non-Scheduled banks. The Scheduled banks can further be
classified into 5 parts, namely Nationalised Banks, SBI and its associates, Regional Rural
Banks, Foreign Banks and Other Indian Private Sector Banks.
According to a KPMG-CII report, the Indian Banking industry has the potential of
becoming the 3rd largest banking industry in the world by 2025 and currently is worth
about 1.31 trillion USD. The industry has done particularly well in the last couple of
years; one of the reasons for this was the Pradhan Mantri Jan Dhan Yojana – a scheme
launched by our Prime Minister which has been responsible for the opening of more
than 175 million bank accounts nationwide as of August, 2015. There have been quite a
few developments in the recent past which have also help trigger this kind of growth in
our banking sector like RBI’s approval for the establishment of 11 payment banks
recently.
Financial statement analysis is the process of reviewing, studying and eventually
analysing a company’s financial statements in order to predict future trends. There are
number of aspects in a company’s financial statements and each one of them needs to
be looked at individually to make decisions. Therefore we need the help of financial
ratios like Performance Ratios, Profitability Ratios, Liquidity Ratios, Management
Efficiency Ratios, Debt Coverage Ratios, Debt Coverage Ratios to analyse them correctly.
Free cash flow to the firm, measures money and time through the use of short- and
long-term assets and earnings before interest, taxes, depreciation and amortization
(EBITDA). FCFF itself is used to measure the risk an investor faces in getting a return
on his investment. As FCFF uses both short- and long-term investments in its
calculations it helps capture the measurement of time. Also each component of the FCFF
equations is over a specific time period, so it is possible to calculate the monthly,
quarterly or yearly FCFF depending on the time frame the investor wants to use. To
calculate FCFF all the non-cash charges including interest and depreciation are added
45. 45
back to capture the actual cash flow of the business, due to the money a company uses
for investments cannot be paid out to investors in the form of cash, those are subtracted
from the equation. Although FCFF is a monetary measure of how much money is
available to investors, it is a great indicator of risk. If the FCFF is low or negative, it
could be a signal the investment is not safe because there is either a low return or no
return. A high amount of FCFF could be a signal there is low risk and the investment is a
good opportunity.
Free cash flow to equity is a measure of how much cash can be paid to the equity
shareholders of the company after all expenses, reinvestment and debt repayment. Free
cash flow to equity (FCFE) is one of the many ways of assessing company value.
Enterprise Value is a measure of a company's total value; it is often used as a more
comprehensive alternative to equity market capitalization. The market capitalization of
a company is simply its share price multiplied by the number of shares a company has
outstanding. Enterprise value is calculated as the market
capitalization plus debt, minority interest and preferred shares, minus total cash
and cash equivalents. It can be thought of as the theoretical takeover price if the
company were to be bought. In the event of a buyout, the acquirer will have to take on
the company's debt, but will pocket its cash for himself. EV differs significantly from
simple market capitalization in several ways, and many consider it to be a more
accurate representation of a firm's value.
Economic Value Added (EVA) is an estimate of a firm's economic profit – being the value
created in excess of the required return of the company's investors (being
shareholders and debt holders). Quite simply, EVA is the profit earned by the firm less
the cost of financing the firm's capital. The idea is that value is created when the return
on the firm's economic capital employed is greater than the cost of that capital. It is
useful for investors who want to determine how well the company has been producing
value for its investors, and it can be compared against the company's peers for a quick
analysis of how well the company is operating in its industry. It is calculated by taking a
company's net after-tax operating profit and subtracting from it the product of the
company's invested capital multiplied by its percentage cost of capital.
Market value added (MVA) is simply the difference between the current market value of
a company and the capital contributed by investors (including both shareholders and
bondholders). MVA is considered to be a wealth metric.
Intrinsic value is the actual value of a company or an asset based on an underlying
perception of its true value including all aspects of the business. This value may or may
not be the same as the current market value. Value investors use a variety of analytical
techniques in order to estimate the intrinsic value of securities in hopes of finding
investments where the true value of the investment exceeds its current market value.
But for call options, it is the difference between the underlying stock's price and strike
price. For put options, it is the difference between the strike price and stock price. In the
case of both put and call, if the respective difference is negative, the intrinsic value is
given as zero. Value investors look at both qualitative (business model,
governance, target market factors etc.) and quantitative (ratios, financial statement
analysis, etc.) aspects of a business to see if the business is currently out of favor with
the market and if it is really worth much more than its current valuation. Intrinsic value
in options is the in-the-money portion of the option's premium.
The banking sector is suffering from poor asset quality, even though the corporate
balance sheets are under stress, HDFC Bank has shown some resilience in terms of asset
quality as its gross NPA’s fell to 0.93% vs 1.00% YoY in the fiscal year , a drop of 7 basis
46. 46
points, but we expect it quality to improve as the economic revival is gaining
momentum.
The aggressive private banking sector has been able to maintain its position with the
public sector bearing the majority of the losses owing to its high exposure to public
policy and schemes. HDFC has done better than its competitors with the net addition to
its gross non-performing assets at 28% in the financial year 14-15.As compared to ICICI
bank, HDFC has fared better in terms of CASA growth. The banks net NPAs were also
lesser when compared to ICICI, the efficiency of the operations reflected in the growth
pattern as well with HDFC growing at 20.6% vs ICICI’s 10% recorded growth. Also
HDFC bank has shown a constant increase in its dividends paid out with a CAGR of
17.46% for dividends and a CAGR of 22.35 for earnings per share, the dividends and
earnings continued to grow in this fiscal as well.
As crude oil prices and inflation are in relaxed ranges, the RBI has lowered the interest
rates by 125 basis points which decreases the cost of borrowing for the banks and helps
them in expanding their credit base. The banking penetration in India is very low when
compared to other developed or developing nations, this can be said by analysing the
low loans to GDP ratio which is at 62% and is said to be relatively low if compared to
other nations. India is expecting to grow at a CAGR of 6.8% through 2012-2017, this will
lead to an increase in per capita income and a rise in the number of people availing the
services of banking, also India has an advantageous demographic dividend with the
working age population expected to increase vastly. The demand for personal finance is
rising due to the rise in per capita income which also leads to a rise in disposable
income and standards of living. Therefore individuals get the room for availing personal
credit which cause rapid urbanisation, increases the popularity of nuclear families and
easier home loans that have led to an increase in demand for housing loans, these loans
provide an effective cushion to the ever changing corporate loans, demand for housing
loans exceeds supply by four times, which represents a huge scope for expansion in an
available market. India has to invest over 1 trillion USD in its infrastructure in the
coming few years to realise its true potential, this investment is expected to come from
bank lendings thereby increasing the net advances of the banking sector. The
headwinds that the economy saw has exposed the banks to a considerable amount of
credit risk. The corporate balance sheets shrunk, HDFC bank managed to shelter itself
from the chaos with the gross and net NPA’s always remaining below 1%.
Our Call:
Given the current scenario, HDFC looks like the most attractive buy in the aggressive
private banking sector, with strong fundamentals and a secure quality asset base, it
enjoys a strong EPS of 38.90 rs, considerably higher than the other giant in the sector
ICICI bank, HDFC also trumps ICICI in terms of asset quality, The bank also enjoys a
robust P/C and P/E ratio second only to Kotak bank which has abnormal valuations due
to its recent acquisition of ING Vyasa Bank , going ahead we expect margins to widen as
interest rates taper and cost of borrowing reduces leading to a broader market base and
higher net profits, the banks high P/E and P/BV is indicative of a strong brand equity
possessed by the bank, the stock has traditionally traded at a P/BV of 4.1, any correction
provides a good opportunity to enter the stock.
