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Valuation of HDFC

This document summarizes the valuation of HDFC Bank using discounted cash flow (DCF) and relative valuation methods. It provides background on the banking industry and HDFC Bank. It then discusses challenges in valuing banks and outlines two DCF approaches - a two-stage dividend discount model and an excess return model. Limitations of DCF for banks are also noted. For relative valuation, comparable companies are identified and multiples like P/E and P/BV are calculated to determine HDFC Bank's value. Limitations of the relative approach are also outlined.

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G Nagarajan
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971 views21 pages

Valuation of HDFC

This document summarizes the valuation of HDFC Bank using discounted cash flow (DCF) and relative valuation methods. It provides background on the banking industry and HDFC Bank. It then discusses challenges in valuing banks and outlines two DCF approaches - a two-stage dividend discount model and an excess return model. Limitations of DCF for banks are also noted. For relative valuation, comparable companies are identified and multiples like P/E and P/BV are calculated to determine HDFC Bank's value. Limitations of the relative approach are also outlined.

Uploaded by

G Nagarajan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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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

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