HDFC Bank: Pare exposures

Recommendation: Pare exposures

Suresh Krishnamurthy

FRESH investments in HDFC Bank need not be considered.

Those with significant holdings can pare exposures. The weight of HDFC Bank in Nifty is 2-2.5 per cent. Any holding higher than this weight can enhance the risk of the portfolio vis-a-vis the index.

HDFC Bank has traditionally been a low-risk investment with significantly low volatility compared to the index. However, the stock's current valuation level can enhance the volatility in the scrip in the near-term.

In terms of financial performance, HDFC Bank has continued to surprise the market. It was expected to maintain the growth momentum, but the extent of rise may have exceeded expectations. The 44 per cent rise in net profits exceeded the 34 per cent recorded in the quarter ended June 2001.

The rise in profits came on the back of strong growth in business. Continued growth in the retail business -- the cornerstone of its performance -- has continued this year too. In the first half ended September 2001, retail accounts increased by 25 per cent over the end-March level. Also, income from non-fund business, such as foreign exchange transactions, registered a healthy rise.

Momentum deceleration

However, there are signs of a possible deceleration in the growth momentum. Deposits with HDFC Bank increased from Rs 11,658 crore at the end of March 2001 to Rs 14,279 crore at the end of September 2001, up 22.5 per cent. However, advances increased from Rs 7,182 crore to Rs 8,177 crore, a rise of only 13.9 per cent. The lower growth rate in advances suggests HDFC Bank may have had to invest a substantial portion of the funds raised in government securities.

There are also other factors. The growth of `Other income' has outpaced that of interest income. This is partly because of the sharp decline in interest rates, allowing the Bank to book profits. Profit on sale of investments was around Rs 45.7 crore in the first half. In the year ended March 2001, the profit on sale of investments was only Rs 11.50 crore.

Interest expended as a proportion of total income also increased during the period in review. Low-cost savings and demand deposits dropped to 33 per cent at the end of September 2001 from around 38 per cent at the end of March 2001. Importantly, provisions rose by only 4 per cent compared to the corresponding half of the previous year though customer assets increased by 72 per cent. However, the portfolio quality continues to be good though the `net non-performing assets to advances' ratio has risen marginally to 0.4 per cent from 0.29 per cent at the end of March 2001.

Beyond 2002

The factors suggested above do not in any way detract from the impressive performance of HDFC Bank in the second quarter ended September 2001. However, these factors indicate that maintaining the growth momentum beyond the next two quarters may be difficult.

Over the next two quarters, maintaining the momentum is unlikely to pose a problem. The cut in the bank rate, the increase in the rate paid by banks on CRR balances, and the cut in the CRR rate would ensure that profitability keeps rising in the near term. But that may not be enough. From the perspective of the stock's valuation, maintaining strong growth beyond the next two quarters is crucial. The stock trades at a price to earnings multiple of around 25 times its earnings for the 12 month period ended September 2001.

In this backdrop, investors can reduce exposure in the stock. However, in the event of a sharp decline in price, they should also look to enhancing exposure as HDFC Bank remains a fundamentally strong investment candidate.