>HDFC BANK (MORGAN STANLEY)

HDFC Bank reported earnings at Rs. 8.4 bn for F4Q10: This was marginally lower than our estimate of Rs. 8.6 bn – driven by a small treasury loss. The core earnings progression was very strong (pickup in loan growth, CASA, NIMs with reduction in credit costs). In fact, if we look at (PBT-capital gains) per share, the core earnings almost doubled YoY in F4Q10.

The bank is in an extremely sweet spot: It is entering a new credit cycle with significant competitive advantages. New NPL formation has decreased to the lowest level in years and it has no legacy NPL book – implying it can potentially run with lower than normalized credit costs. Moreover, its competitors are still trying to work out legacy issues – implying less competition and hence better returns. Moreover, with a Tier 1 ratio of 13.3%, the bank is extremely well capitalized to grow rapidly.

We are building in 30% CAGR in EPS over the next two years: We have not changed our headline earnings much, but we have improved the quality of earnings in our estimates (took down capital gains to zero).

Potential upside to earnings could come from better asset growth (we are building in 26% loan growth for the next two years) and lower credit costs (we are at 125 bps but could be lower if last quarter’s NPL formation trend continues).

At 22x F2011e earnings, multiples are not cheap – but given the outlook, we think they can be
sustained: On PEG, the stock is trading below its long-term average. Given the strong growth outlook, we can see the bank continuing to trade at current multiples. With earnings growing meaningfully, this could cause the stock to deliver good returns. Our new target price is
Rs. 2400 (implying 20.8x on F2012e earnings).

To read the full report: HDFC BANK