HDFC Bank Upgraded to Neutral

Zacks

We are upgrading our long-term recommendation on HDFC Bank Ltd. (HDB) to “Neutral” from “Underperform”. The rise is based on the company’s significant exposure to the faster growing retail credit market and decent fiscal third-quarter results.

Moreover, we anticipate the continuously expanding branch network of the company to drive growth in deposits and loans. However, HDFC Bank is still exposed to the threat related to higher cost of funds and increasing competition in the retail space with the re-entry of its peers.

We believe that HDFC Bank’s Retail Banking segment will be the key driver for earnings growth going forward. In 2011, this segment was a major source of profit for the company. Given the boom in the Indian retail credit market and HDFC Bank’s extensive branch network, the company is expected to gain significant market share in the retail credit sector.

HDFC Bank’s main strategy is to enhance its market share in India’s banking and financial services areas. The company has been able to carry out this plan through development of new products, conducting disciplined credit risk management as well as delivering exceptional service to its customers.

On the flip side, the re-entry of various competitors into the retail segment, after nearly two years, has led to severe competition. The company mainly competes with other private banks in India such as ICICI Bank (IBN), UTI Bank, IDBI Bank, IndusInd Bank and state owned banks, as well as foreign banks that have a notable presence in the country, including Citibank, HSBC Holdings Plc (HBC) and Standard Chartered.

Additionally, most of the Indian banks are anticipated to encounter higher cost of funds as they have to raise the deposit rates to meet increasing loan demand. This will likely keep margins of some banks, including HDFC Bank, under pressure. On the other hand, lending rates are expected to climb faster in the upcoming quarters leading to lower demand for loans.

Currently, the shares of HDFC Bank retain a Zacks #2 Rank, which translates into a short-term ‘Buy’ rating.

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