Merrill Lynch has raised the price objective on HDFC Bank to Rs 1435.Research firm sees high visibility of earnings growth sustaining at +30% CAGR through FY09, underpinning our new PO of Rs1435.

Raising PO to Rs1435; USD 110 on ADR

We are raising our PO to Rs 1435 on the domestic stock and USD 110 on the ADR as we believe the stock, trading at 4.3x FY08E adj. book (factoring in HDFC’s equity infusion) could continue to trade around the 4.3-4.5x multiples one year forward as long as it delivers on earnings, as the stock would, in our view, move in sync with the earnings growth. We continue to see high visibility of earnings growth sustaining at +30% CAGR through FY09, underpinning our new PO of Rs 1435. A sharp rise in rates or NPLs is the key risk to our PO.

1QFY08 earnings 3-4% higher than estimated

HDFC Bank’s 1QFY08 earnings were about 3-4% higher than estimated, driven principally by stronger non-interest income. While top line (net interest income) was a tad lower, it was owing to a mismatch of balance sheet and revenue growth and the higher funding costs of the previous quarter, which was expected. Asset quality remains steady with gross NPLs at 1.3% of customer assets and net NPLs at 0.4%. Loan growth at 33% was few notches higher as the results reinforce that the bank continues to be on a strong growth trajectory.

Earnings raised by 2-3%; to grow at 30% CAGR through FY09

We have raised earnings by 2-3% for FY08-09E to factor in stronger loan growth and higher than envisaged non-interest income. Moreover, building in the equity infusion by HDFC Ltd (USD 330 million), margins are likely to be steady, resulting in stronger earnings growth. This assumes high NPL coverage after factoring in an uptick in the NPL cycle. Net NPLs forecast at <0.5% through FY10.

Looking ahead – FY08; earnings growth at 30%

We are raising our earnings by 3% for FY08E and 2% for FY09E on the back of greater visibility on the bank’s ability to generate loan growth of +34-35% and possibility of margin compression being less than forecast by us. We now expect a 30% CAGR growth in earnings through FY08-09. Key earnings drivers are likely to be:

Loan growth of around 35% v/s earlier estimates of 30-31% yoy

Margins to be steady v/s a 8-10bps compression assumed earlier owing to equity infusion of USD 330 million by HDFC Ltd and changing loan profile. We are still penciling in a moderation in CASA (share of low cost deposits) levels to 50-51% as we do think the 55% level (FY07) is not sustainable as it has been driven by run down of high cost deposits.

Fee revenues are likely to be higher at +35% yoy (and would show the expected rebound) supported by enhanced customer acquisition especially as the bank has expanded its distribution network very aggressively in the past 6 months.

We continue to factor in higher credit costs arising from our view of an uptick in the NPL cycle and change in the loan mix towards higher yielding buy relatively riskier loans.

Strong volume growth with easing margin pressures

We believe loan growth could be a few notches higher at +34% owing to the enhanced penetration of its products and ongoing buoyancy in its retail (non-auto) business and sustained uptick in the corporate loan growth cycle. Moreover, we estimate margins may be steady owing to the equity infusion by HDFC and the share of low cost deposits sustaining at +50% levels v/s 47-48% assumed earlier.