HDFC Banks on India's Growth

As readers might have noticed from some of my past articles, I remain an unabashed bull about foreign equities in general, and emerging-market stocks in particular. Heck, I know that this asset class is risky at the best of times -- and investor sentiment these days is certainly skittish with regard to anything smacking of risk. But the long-term rewards can be substantial, as illustrated by such quality emerging-market plays as oil giant PetroChina (NYSE: PTR  ) and cell-phone operator American Movil (NYSE: AMX  ) .

To butcher a quote from George Orwell's immortal Animal Farm, some emerging-market stocks are more equal than others. These stocks, as a rule, are their countries' "blue-chip" companies, creating high barriers to entry by holding either a dominant share of their targeted markets -- think China Life's (NYSE: LFC  ) 44% share of the life insurance market -- or a proprietary position in some other way (GrupoTelevisa's (NYSE: TV  ) hold on Spanish-language programming comes to mind).

That said, there are exceptions to every rule, and HDFC Bank (NYSE: HDB  ) , one of India's top mortgage lenders, is one. While the company is considerably smaller than its larger private-banking rival ICICI Bank (NYSE: IBN  ) , I believe that HDFC's demonstrated operational excellence -- not to mention its focus on serving upper- and middle-class customers -- will allow it to reap substantial benefits from India's continued economic growth, and from the expansion of the country's relatively underdeveloped credit markets. (For the purpose of this article, I will use the terms "credit" and "loan" interchangeably).

Let's take a look, shall we?

India's economic growth
According to the International Monetary Fund's recent biannual report, World Economic Outlook, India's economy is projected to grow by roughly 7.3% in 2006 -- powered by strong performances in the manufacturing and services sectors -- and by a further 7% in 2007. As Asian Development Bank President Haruhiko Kuroda recently noted, "India's GDP will double in 10 years if there is a 7% growth rate".

To risk stating the obvious, as India's economy powers ahead, the ranks of the country's 300 million middle-class consumers will continue to grow, as will demand for consumer goods. India's annual sales of passenger cars are expected to nearly double to 2 million by 2010; a current nationwide housing shortage of more than 22 million units, according to the National Real Estate Development Council, should help fuel housing growth.

Hmm, I wonder . how will companies fund the construction of those new power plants needed to satisfy demand, and how will that newly hired software engineer purchase a recently renovated apartment in the chic part of town?

One word: Credit.

India's credit markets
According to The Silk Road To Riches, by Mostrous, Gue, and Martchev, in 2004 India had total loans outstanding in the economy of just $221 billion. That's a mere 35% of its $649 billion in GDP. In contrast, economic rival China sported a GDP-to-loan ratio of close to 140% during that period, roughly in line with other regional economies such as Australia and Korea. In essence, China's economy was a little more than twice the size of India's, but had 10 times more loans outstanding.

Aside the obvious prospects of lending to expanding corporations such as Tata Motors (NYSE: TTM  ) , Indian banks have even greater opportunities for growth in the consumer market. Take card issuance and the home mortgage market, for example.

According to Visa, the world's largest credit card company, fiscal 2005 was a banner year in India, with spending on its credit cards growing 66% to $3.8 billion. To put that number in perspective, American consumers spent more than $1.5 trillion on all credit cards during the same period.

The scale of opportunity in the home mortgage market is similarly impressive. The National Real Estate Development council recently reported that mortgages only accounted for 2% of India's GDP, compared with 54% in the U.S.

I know, I know, pretty dry stuff, but it amply illustrates that India's banks have pretty of room to grow. HDFC Bank is well-positioned to capitalize on these opportunities.

In a prime spot
HDFC Bank is one of the top mortgage lenders in India, and one of the country's fastest-growing banks. As of the end of the fiscal year ended March 31, 2006, the company had 535 branches in 228 cities nationwide, as well as 1,323 ATMs, all linked online in real time. HDFC has three divisions -- Retail Banking, Wholesale Banking, and Treasury -- offering everything from mortgages to credit cards to derivatives, and even gold trading. It also offers third-party products such as life insurance from sister company HDFC Standard Life, as well as mutual funds.

HDFC has distinguished itself as an extremely efficient operator. For example, HDFC boasted an average cost of deposit of 3.3% for fiscal year 2006, down from 3.9% in 2004, and one of the lowest rates in the industry. Net interest margin stood at 4%, well ahead of the 2.4% posted by rival ICICI Bank, and up from 3.8% in 2004. Non-performing loans stood at 1.2%, lower than even many Western banks, and the company had a Tier 1 capital ratio (basically required reserves) of 8.3%, nearly twice the Reserve Bank of India's requirement of 4.5%.

In simple terms, this operational efficiency, coupled with the company's growing customer base -- now 9.6 million, up from 1.4 million in 2001 -- has enabled HDFC to post a compound annual earnings growth rate exceeding 30% since it went public back in July 2001.

Call me a Fool, but I expect this stellar growth to continue, fueled by the growing demand for credit from India's middle class. HDFC's card business has grown to nearly 3.9 million debit cards and 2.4 million credit cards (up 86% and 380%, respectively) and carries higher margins than the traditional loan business. Furthermore, while the company's mortgage sales have been growing strongly, there remains plenty of room for growth, since HDFC holds less than 5% of India's fragmented loan market.

Shares of HDFC Bank aren't exactly inexpensive, trading at around 17 times forward earnings. I know that's pretty rich -- especially for an emerging-market bank in these uncertain times -- but it does represent a 43% discount to its projected long-term growth rate, which may likely prove conservative.

That said, don't invest your grandmother's nest egg here. I would strenuously suggest that only investors with a long-term viewpoint -- and a cast-iron tolerance of volatility -- take a long look at HDFC, and see if they'd like to make a deposit for the future.

Check out the Motley Fool International Report for more global investing ideas.

Fool contributorWill Frankenhoffis enjoying his time writing for The Fool even more than playing golf, reading The Financial Times or taking a nap. He welcomes your feedback atelves1us@yahoo.com. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 506056, ~/Articles/ArticleHandler.aspx, 11/22/2014 8:40:41 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement