“With the cross-selling benefits kicking in, we are looking at a giant bank which will make ROE north of 20%, potentially growing the loan book at north of 20%. One cannot ask for more than that in a large well-run bank,” says Saurabh Mukherjea , Founder, Marcellus Investment Managers.
The HDFC-HDFC Bank merger will take 12 to 15 months to complete. So for shareholders right now, can the next 12 to 15 months be a period of no return or low return because that marriage is still a distance away and right now it is only engagement?
I do not think we have to worry so much about the shaadi (marriage), I think shaadi to ho jayegi (the marriage is final).
There is something called a runaway bride?
The growth numbers that HDFC Bank posted for the quarter ending March showed blistering growth. I think they are growing on both sides of the balance sheet at around 25%. Bajaj Finance by the way posted similar growth numbers yesterday. So leaving aside the merger which we like and which we are very happy about, just the sheer blistering pace of growth in HDFC Bank on both sides of the balance sheet means that we as shareholders will continue compounding regardless of the merger modalities.
And this has been the story of HDFC Bank. For the last three years, they have pulled 3% market share away from the rest of the banking system. No other private sector bank has remotely matched them in the last three years in sheer pace of growth of this clearly well run bank. So let me focus on the economic recovery and HDFC Bank’s growth that itself has a next 12 months of upside solidly locked in there.
Let us understand the return ratios and how they would move. The bank currently is enjoying a return ratio which is higher than HDFC Ltd . In the combined entity for the banking business per se, the return ratio comes down. Have HDFC Bank shareholders got a raw deal and HDFC shareholders got a better deal?
I think it is a slightly different way of looking at it, The way we have done the maths is HDFC Bank’s ROA is already around 2%, HDFC Ltd’s ROA with HDFC Bank’s cost of funding – so if you take HDFC Ltd’s loan book and put it on HDFC Bank’s cost of funding – even after factoring in CRR and SLR, will still comfortably make a 2% ROA on the acquired book.
If you take the acquired book and put on it the new cost of funds, the HDFC Bank cost of funds, subtract from it CRR and SLR, one will still comfortably make a 2% ROA. Secondly, once you lever up HDFC Bank post the deal, leverage comes down because HDFC Ltd is less geared up than HDFC Bank. So one has to lever up the entity to 10x debt equity which should be very doable. We are comfortably looking at the bank with ROEs north of 20%. So if you take that 2% ROA work with that, we are confident that both entities will have a 2% ROA even after CRR, SLR and then lever up 10x and you are at 20% ROE.
My reckoning is with the cross selling benefits kicking in, we are looking at a giant bank which will make ROE north of 20%, potentially growing the loan book at north of 20%. You cannot ask for more than that in a large well run bank.
The technical factor is that the market cap of HDFC Bank and HDFC Ltd is about 14-15%; the combined entity may be a restrictive factor for a lot of mutual funds because mutual funds are not allowed to own one single entity for more than 10% stake. Could that lead to adjustments? Even in your portfolio, you may not want to take in more than 10-11% exposure to a single stock?
This is a very good point you make and I am not so sure the Indian mutual fund will be a critical driver. Over the next 10 years, we will see the rise in the alternatives industry, the rise of firms like us because we are a PMS and do not face any SEBI imposed restrictions on position sizing. Our largest position is Asian Paints is around 12-13% of our portfolio. HDFC Bank was our second largest position, we are around 9%. As we get more clarity on the deal mathematics […]
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