Valuation of HDFC Bank

AGENDA
• Banking Industry Background
• About HDFC
• Challenges in Valuation of Banks
• Valuation using DCF
• Valuation using relative valuation
About the Banking industry

Banking Deposits = $1.5 trillion (with a CAGR of 11.4%)

Unbanked population in India = 41%

Total Banking Assets = $1.8 trillion (with a CAGR of 11.3%)

No. of commercial banks in India = 157

India’s bank penetration score = 42.8

About HDFC Bank

• Banking and Financial services company

• Promoted by HDFC (a housing finance company)
What • Largest private sector bank by m-cap
• Products – Private Banking, Corporate Banking, Mortgages, Credit Cards, Wealth Management, Investment
Management etc.

When • Incorporated in Aug ‘94

• IPO in March ‘95

Where • HQ at Mumbai

Who • MD – Aditya Puri

• Beta = 1.13 PE = 27.26

Numbers • EPS = 40.76
• ROE = 19.8% Dividend Yield = 0.73%
Challenges in Valuation of Banks
• Difficult to define debt and reinvestment
• More akin to “raw material” than a source of capital for banks
• Defining working capital and capital expenditures
• Heavily regulated: Adds a layer of uncertainty (risk)
• Required to maintain capital ratios
• Constrained in terms of where they can invest their funds
• Entry of new firms regulated
• Accounting rules significantly different from rules of other firms
Challenges in Valuation….(Contd.)

• Interest expense
• Operating expense / Interest Expense ??
• Estimating cash flows difficult
• No concept of EBIT/PBT in banks
• Capital expenditures mainly for intangible assets
• Enormous fluctuations in Working Capital
(CA – CL = Working Capital)
• Estimate of expected growth rate difficult
DCF Methods
• Equity Valuation rather than Firm Valuation
• Difficult to estimate WACC
• With FCFE, difficult to classify debts again
• Two Methods:
• Dividend Discount Model
• Present Value of Expected Dividends
• Excess Returns Model
• Equity capital invested + PV of excess returns to equity investors
2-stage Dividend Discount Model
• High growth period (2016-2020)
• Use Average ROE and BV of equity to calculate net income for the year
• Calculate dividend using dividend payout ratio
• Add retained earnings to BV of equity to get the book equity capital for next
year
• Discount the dividends to the present using the cost of equity as the
discounting factor
2-stage Dividend Discount Model

• Stable Growth period (2020 onwards)

• Terminal growth rate: 7%
• Number of outstanding shares: 2511458217

Present Value
Cost of Terminal Total Value per
Scenario ROE of Terminal
Equity Equity Value Value share
Value

Optimistic 22% 9% 908527 522628 533054 2122

Intermediate 17% 10% 403790 232279 242705 966

Pessimistic 14% 12% 169592 97557 107983 430

Excess Return Models
• Value of Equity = Equity Capital Invested Currently + PV of Expected Excess Returns to Equity
Investors
• Excess Equity Returns = (Return on Equity – Cost of Equity)(Capital Invested)
• Terminal Value
Limitations of DCF models

• Consistency is important: Growth vs Dividends

• Dividend forecasts is difficult
• Expected ROE estimation is a challenge
• Cost of equity assumed constant for high growth as well as stable period
• Terminal Growth Rate Assumption (current GDP growth rate)
 Relative
Valuation
Factors for identifying the
Comparable Companies/Peer Group
Correlation
Quantitative Factors Qualitative Factors
 Cost of Equity  Industry, Business model, Market
Positions
 Expected Growth rate in Earnings
 Payout Ratio or Retention Ratio  Life-cycle stage

 Size  Differences in customer base

 Accounting Policy, Financial years
 Financial Structure
 Identifying the appropriate multiples

 Enterprise Value Equity Multiples Equity Multiples

Multiple
 EV/Revenue
 EV/EBITDA
• P/E • P/E
 EV/EBIT • P/BV • P/BV
 EV/Sales • P/Sales

 Equity Multiples
P/E : function of three variables –
 P/E
the expected growth rate in
 P/BV earnings, the payout ratio and the
 P/Sales cost of equity
Chosen Comparable Companies

 SBI Bank
 ICICI Bank
 Axis Bank
 Kotak Bank
 Valuation - Multiple Estimation

Company Name Full Year (Rs Cr.) Price Information Multiples TTM (Rs Cr.)
NP B.V Rs EPS Rs. Price Price Date Mkt. Cap. P/E P/BV TTM NP EPS Rs. P/E
HDFC Bank 10,208.55 62,009.42 39 1,111.00 31-Jul-15 279,341.10 28.5 4.5 201506 10,671.23 42.45 26.17
St Bk of India 13,129.51 128438.22 16.7 270 31-Jul-15 204590.5 16.2 1.55 201503 13,129.51 16.7 16.2
ICICI Bank 11,170.56 80,421.92 18.8 303 31-Jul-15 175594.4 16.1 2.19 201506 11,491.42 19.8 15.31
Axis Bank 7,360.16 44676.51 30.1 574 31-Jul-15 136321.6 19.1 3.05 201506 7,671.84 32.29 17.78
Kotak Mah. Bank 1,857.08 14141.09 10.1 696 31-Jul-15 127111 68.9 8.95 201506 1,617.06 8.85 78.64

Median 19.1 3.05 17.78

Avg 29.76 4.048 30.82

M.Value(Cr.) (=P/E * NP) (=P/E * BV) (=P/E * NP)

Total Shares 2511458217 303806.45 251014.13 314627.51

Target Price 1209.68 999.48 1252.77

Sources: Capitaline Database

Limitations of Relative Valuation

 Market is correct – Assumes markets are correct in the

aggregate, which may not be true
 Difficult to compare – Several reasons multiples can differ for
different companies. For eg, different accounting policies can
result in diverging multiples
 Simplistic – Makes it difficult to disaggregate the effect of
different drivers on value. This may lead to simplistic
interpretation
 Static valuation - Fails to capture the dynamic and ever evolving
nature of business
 Annexure -1

Src: Bloomberg Database

 Annexure -2

Src: Bloomberg Database

 Annexure -3

Src: Bloomberg Database

 Back
Annexure : Correlation - Peers

Src: Bloomberg Database