Why you should buy HDFC Ltd. shares

Can the elephant dance is the popular questions doing the rounds regarding the HDFC - HDFC Bank merger. Elephants are characteristic of being protective, with one foot always on the ground. They are alert and despite the size, are fast runners. Post the merger, the combined entity may likely take these qualities of an elephant, if not be known for the dance. At Rs 18 lakh crore of loan book, HDFC Bank may remain an unmissable stock in the portfolio. But ahead of the merger, here are four critical boxes to check.

Shareholders’ strategy

Stocks of HDFC Ltd and HDFC Bank enjoy enormous popularity among all categories including retail investors. Post-merger, HDFC Bank stock’s weightage in Nifty is set to increase to 14 per cent from 8.43 per cent. So, first check on a combined basis how heavy is the HDFC Bank stock in your portfolio. If the weight is too much, you run the risk of putting all the eggs in one basket. If not, you may be inclined to increase the exposure following the merger news. In that case, investors could consider buying shares of HDFC Ltd, as it offers better upside over the bank’s stock on a consolidated basis (see table).

What if you are already holding HDFC Bank shares? Then, utilising the merger upside could be wise. Exit your position in HDFC Bank and buy shares of HDFC Ltd. If you hold both the shares but there is room to increase the holdings, buy shares of HDFC Ltd. As for the bank’s shares, you can continue holding them. But if you are inclined to take a tactical call, selling shares of HDFC Bank and increasing the position in HDFC Ltd is an option. Please note this is an illustrative recommendation. Factor in the tax liability and incidental costs while taking the decision.

Also read

HDFC – HDFC Bank merger: End of an era for the group’s veterans?

Also, both stocks are widely held by domestic and foreign institutional investors who are bound by the 10 per cent cap on single stock weightage in their portfolio. Hence ahead of the merger, fund houses may prune their stakes, which could keep the stocks under pressure. This rebalancing has started playing out and partly explains why the two stocks pared most of April 4’s single day gains over the course of the week.

Also note, HDFC Limited consistently has offered higher dividend compared to the bank. Average dividend yield of HDFC Bank since FY16 works out to about a per cent. Its over four per cent for HDFC Limited during this period, as until FY19 it paid dividend twice a year. Gear up for a reset in dividend pay-outs.

Who gains more

On the face of it, the merger seems to be a win-win.

HDFC Limited gets wider access to banking products which would help retain customer. For HDFC Bank, the share of housing loans will increase from 11 per cent to 33 per cent of its total loan book. With this, a major criticism about its retail book being skewed towards unsecured loans will be addressed.  But there are equal measures of pain.

A much older housing finance business folds into the bank and HDFC Limited’s operational autonomy may reduce or vanish to comply with the bank’s style of functioning. HDFC Limited’s interest rate is higher compared to industry’s 6.45 – 6.5 per cent rock bottom rates. Even if the rate cycle reverses by the time the merger fructifies, HDFC may not have its freehand in pricing loans if it should stay competitive in the market. Likewise, the stickiness of HDFC Limited’s Rs 1,50,131 crore of deposits (in FY21) will be tested when it is integrated with the bank which would offer much lower rates on its deposits.

For HDFC Bank, which holds a record for maintaining its net interest margin (NIM) at four per cent or more since 2014, the direct implication on profitability is unavoidable. Home loans carry NIM of 3.6 per cent and hence the assets rebalancing will weigh on HDFC Bank’s profitability.

Therefore, there is gain and pain for both in the merger. On one hand, HDFC Limited will cede its jewel crown built over years, while HDFC Bank will give up on its profitability, which has been its USP.

Regulatory tangles

If HDFC Bank’s loan book increases to ₹18 lakh crore from ₹12.7 lakh crore (as on Q3 FY22), the requirements for priority sector lending (PSL) will also go up. In the initial years post-merger, the bank could dip into PSL bonds to shore up this book. This could impact the bank’s carrying cost of funds by two per cent annually. There are also statutory reserves - cash reserve ratio and statutory liquidity reserve ratios to maintain, burden of which may be ₹70, 000 – 90,000 crore. All put together, a compression in HDFC Bank’s NIM by 100 – 125 basis points seems likely.

Next, there’s the tricky question around RBI’s comfort in allowing the bank to operate non-bank subsidiaries. Regulator’s stand on this aspect has been very subjective. While ICICI Bank needs to prune its stakes in its insurance arms to 30 per cent, Axis Bank didn’t get a go-ahead to hold 30 per cent stake in Max Life Insurance. It was allowed to hold only 10 per cent. RBI’s comfort with HDFC Bank holding 50 per cent or more stakes in insurance arms (life and general) and NBFC businesses post the merger is unclear. If stakes are to be hived off as a prerequisite to the merger, that would put pressure on the stocks of HDFC Life and HDFC AMC. But if HDFC Bank should prune its stake post-merger, it may be a blessing in disguise.

In FY17 – FY19 if ICICI Bank and SBI didn’t raise capital despite the need that arose due to asset quality pressures, IPOs/ stake sale across subsidiaries helped. Likewise, subsidiaries may be advantageous rather than a burden for HDFC Bank, though the holding company discount on the stock could increase from the present five per cent level.

What to expect

In the Big Story of Portfolio edition dated March 20, we told you how the HDFC group companies, including the bank and housing finance arms are set for a slower pace of growth. One of the contributing factors was the book sizes becoming larger than before. With the merger set to conclude by FY24, the merged bank may have an asset size of ₹20 lakh crore(factoring for 6 – 8 cent CAGR growth in FY23 - 24), placing it second to SBI in balance sheet terms. It’s loan book would be around 8.5 per cent of India’s estimated GDP. Banking as sector is a play on the country’s economy. Therefore, an overall economic slowdown won’t spare HDFC Bank.

Also, HDFC Bank along with SBI and ICICI Bank are classified as banks ‘too large to fail’. With this tag, comes greater regulatory oversight. Until now, HDFC’s home loans, education loans and investments held under HDFC Limited weren’t subjected to close supervision. That will change.

But the good part is trouble in one segment – say agri, auto or SME loans may not have an exaggerated impact on the overall book because of loan book diversity. Expect the loan growth and asset quality to be at a steady rate. Post merger, investors should treat HDFC Bank stock like a safe haven stock . Expect steady returns, mimicking the Nifty or Sensex. After all, its a rate sight to see the elephant dance!

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