Will HDFC Bank shares continue to command premium over ICICI Bank post merger?

HDFC-HDFC Bank merger got effective from July 1 and the record date for the same is July 13. A head-to-head comparison between the HDFC Bank merged entity and ICICI Bank suggests that the two lenders are similar in terms of loan mix and profitability after the merger. While a couple of brokerages see over 20 per cent upside on HDFC Bank shares, Axis Capital believes the premium valuations that HDFC Bank enjoyed over ICICI Bank may not sustain, at least in the near term.

Axis Capital noted that HDFC Bank has been consistently doing well, but ICICI Bank has improved significantly in recent years. HDFC Bank does a better job in terms of efficiency and productivity metrics whereas ICICI Bank has a much larger contingency provision buffer, Axis Capital said.

"Post merger, the two banks will look similar in terms of balance sheet mix and RoA Du-Pont profile. While HDFC Bank has traded at a significant premium to ICICI Bank (core bank) in the past, we expect the two to trade at largely similar valuation multiples in near to medium term," the domestic brokerage said.

For the merged HDFC entity, net interest margin (NIM) is likely to decline immediately after the merger before it starts improving over time. However, a low opex ratio and credit costs should still lead to a 2 per cent return on assets (RoA), Axis Capital said.

Nomura India sees the merged entity to deliver 1.9-2.1 per cent RoA while Morgan Stanley sees post-merger RoA to remain in the 1.9-2 per cent range. This brokerage 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.

The merger is seen offering portfolio diversification to HDFC Bank. The share of secured loans will increase, and the average tenor of the loan book will go up. HDFC Bank’s loan mix as of March entails retail loans at 39.3 per cent, commercial & rural loans at 39 per cent and corporate loans at 25.4 per cent of total loans. Mortgage loans comprising home loans (6.3 per cent) and loans against property (LAP) (4.8 per cent) form 11.1 per cent of total loans and are part of retail loans.

"Post merger, we estimate the share of mortgage (home loans + LAP) to increase to 31 per cent in FY24, retail (ex-mortgage) to be at 20 per cent, commercial and rural to be at 30 per cent, and corporate to be at 20 per cent. ICICI Bank has steadily increased its loan mix towards retail loans, from 35 per cent in FY13 to 63 epr cent as of FY23. It slowed down the growth in domestic corporate and overseas loans over FY16-20 largely due to higher credit losses in these segments. Mortgage loans form 34 per cent of total loans as of FY23 vs 20 per cent in FY13 and 31 per cent in FY20," Axis Capital said.

In a June 21 note, Nomura India said HDFC Bank underperformed the broader Nifty Bank index significantly over the past two years despite its strong delivery on loan growth, RoE and more recently, deposit growth.

The stock's valuation is currently at 2.5 one-year forward book value is against 10-year average of 3.3 times. Nomura said changes to top management and a broader pick-up in RoE delivery by peers (where HDFC Bank used to command a relative premium) have been key drivers for this. It suggested the target price for HDFC Bank at Rs 1,895.

Morgan Stanley, however, believes HDFC Bank is a compounder available at attractive valuations. It 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 other subsidiaries, and geographical reach are superior to those of most private banks, the foreign brokerage said. This brokerage has a target of Rs 2,110 on the stock.