Relative Valuation

Valuation of HDFC BankINVESTMENT ANALYSIS| GROUP 11SECTION AAzaan Ateef A 14P014 Karan Gupta 14P024Shobhit Garg 14P048Udit Upreti 14P056 Vishal Garg 14P058 AGENDABanking Industry BackgroundAbout HDFCChallenges in Valuation of BanksValuation using DCFValuation using relative valuationAbout the Banking industryAbout HDFC Bank

Challenges in Valuation of BanksDifficult to define debt and reinvestmentMore akin to raw material than a source of capital for banksDefining working capital and capital expendituresHeavily regulated: Adds a layer of uncertainty (risk)Required to maintain capital ratiosConstrained in terms of where they can invest their fundsEntry of new firms regulatedAccounting rules significantly different from rules of other firmsChallenges in Valuation.(Contd.)Interest expenseOperating expense / Interest Expense ??Estimating cash flows difficultNo concept of EBIT/PBT in banksCapital expenditures mainly for intangible assetsEnormous fluctuations in Working Capital(CA CL = Working Capital)Estimate of expected growth rate difficult

6DCF VALUATIONDCF MethodsEquity Valuation rather than Firm ValuationDifficult to estimate WACCWith FCFE, difficult to classify debts againTwo Methods:Dividend Discount ModelPresent Value of Expected DividendsExcess Returns ModelEquity capital invested + PV of excess returns to equity investors

2-stage Dividend Discount ModelHigh growth period (2016-2020)Use Average ROE and BV of equity to calculate net income for the yearCalculate dividend using dividend payout ratioAdd retained earnings to BV of equity to get the book equity capital for next yearDiscount the dividends to the present using the cost of equity as the discounting factor

2-stage Dividend Discount ModelStable Growth period (2020 onwards)Terminal growth rate: 7%Number of outstanding shares: 2511458217

ScenarioROECost of EquityTerminal Equity ValuePresent Value of Terminal ValueTotal ValueValue per shareOptimistic22%9%9085275226285330542122Intermediate17%10%403790232279242705966Pessimistic14%12%16959297557107983430Excess Return Models Value of Equity = Equity Capital Invested Currently + PV of Expected Excess Returns to Equity InvestorsExcess Equity Returns = (Return on Equity Cost of Equity)(Capital Invested)Terminal Value

Limitations of DCF modelsConsistency is important: Growth vs DividendsDividend forecasts is difficultExpected ROE estimation is a challengeCost of equity assumed constant for high growth as well as stable period Terminal Growth Rate Assumption (current GDP growth rate)Relative ValuationFactors for identifying the Comparable Companies/Peer GroupQuantitative FactorsCost of EquityExpected Growth rate in EarningsPayout Ratio or Retention RatioSizeFinancial Structure

Qualitative FactorsIndustry, Business model, Market PositionsLife-cycle stageDifferences in customer baseAccounting Policy, Financial years

CorrelationIdentifying the appropriate multiplesEnterprise Value MultipleEV/RevenueEV/EBITDAEV/EBITEV/Sales

Equity MultiplesP/EP/BVP/Sales

Equity Multiples

P/EP/BV

Equity Multiples

P/EP/BVP/Sales

P/E : function of three variables the expected growth rate in earnings, the payout ratio and the cost of equityChosen Comparable CompaniesSBI BankICICI BankAxis BankKotak Bank

Valuation - Multiple EstimationCompany NameFull Year (Rs Cr.)Price InformationMultiplesTTM (Rs Cr.)NPB.V RsEPS Rs.PricePrice DateMkt. Cap.P/EP/BVTTMNPEPS Rs.P/EHDFC Bank10,208.5562,009.42391,111.0031-Jul-15279,341.1028.54.520150610,671.2342.4526.17St Bk of India13,129.51128438.2216.727031-Jul-15204590.516.21.5520150313,129.5116.716.2ICICI Bank11,170.5680,421.9218.830331-Jul-15175594.416.12.1920150611,491.4219.815.31Axis Bank7,360.1644676.5130.157431-Jul-15136321.619.13.052015067,671.8432.2917.78Kotak Mah. Bank1,857.0814141.0910.169631-Jul-1512711168.98.952015061,617.068.8578.64Median19.13.0517.78Avg29.764.04830.82M.Value(Cr.)(=P/E * NP)(=P/E * BV)(=P/E * NP)Total Shares2511458217303806.45251014.13314627.51Target Price1209.68999.481252.77Src: Capitaline DatabaseLimitations of Relative ValuationMarket is correct Assumes markets are correct in the aggregate, which may not be trueDifficult 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 interpretationStatic valuation - Fails to capture the dynamic and ever evolving nature of business

Thank you!Annexure -1

Src: Bloomberg DatabaseAnnexure -2

Src: Bloomberg DatabaseAnnexure -3

Src: Bloomberg Database