Morgan Stanley says HDFC Bank a compounder at attractive valuations, resumes overweight stance

Foreign brokerage Morgan Stanley believes HDFC Bank is a compounder available at attractive valuations. The brokerage has resumed its overweight stance on the stock with a target of Rs 2,110, which suggests a potential 24 per cent upside ahead.

Morgan Stanley said the HDFC-HDFC Bank merger is synergistic, with HDFC Bank getting access to secured and long tenor retail mortgage product as well as a large customer base. HDFC Bank's product suite, its direct access to insurance, and geographical reach are superior to those of most private banks, the foreign brokerage said.

Morgan Stanley expects a re-rating for HDFC Bank over the next year as it sees post-merger profitability (RoA) to remain in the 1.9-2 per cent range and expects loan growth accelerates to 18 per cent over the next year, compared to current pro forma merged loan growth of 15-16 per cent.

"We value the bank at 17 times one-year forward earnings and add Rs215 for subs (after 20 per cent holding company discount). The key re-rating catalyst would be strong execution on deposit growth. Key downside risk could be high than expected competitive intensity on pricing of deposits/loans," Morgan Stanley said.

Morgan Stanley said strong trailing investments and improving macro conditions should help accelerate the merged entity's loan growth rise from 15-16 per cent currently to 18 per cent YoY over the next year.

It said strong branch expansion and increased focus on cross-selling across divisions should drive deposit growth faster than

loan growth. Improving real deposit rates over the past year will also help, Morgan Stanley said.

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The brokerage expects steady trends for margin after the merger. Following initial moderation of 20-30 bps, it expects margins to remain in a tight range, helped by loan mix shift away from corporate lending, gradual shift of higher-cost borrowings into retail deposits and lagged repricing of the fixed rate loan book.

Morgan Stanley said the merged entity's strong asset quality and low credit costs should help accelerate investments and enable better management of merger-related challenges.

"HDFC Bank has already accelerated the pace of branch expansion, which is also aided in part by low credit costs. We believe this can continue over the next few years. In our view, this would be helpful to sustain loan and deposit market share gains over the medium term," it said.

Also, as HDFC Bank exits the investment cycle and productivity and cross-selling improve, Morgan Stanley expects sustained moderation in cost ratios for multiple years.

"The stock is trading at 16x one-year forward EPS, which we think is very attractive," it said.

"Cyclical tailwinds and strong execution will help navigate merger related challenges better. We expect EPS growth to be 18 per cent YoY post year 1 of merger. Asset quality is robust, given strong underwriting capability and lending to prime borrowers across segments. Capitalisation is good with standalone Tier-1 ratio at 17.1 per cent and will further improve on merged basis," it said.

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