This Bank is a Screaming Buy!

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

India is the second most populated country in the world and according to Citigroup, its GDP is expected to grow around 5.7%-6.2% in FY14. For a new normal, that is still impressive! Although, the country’s reputation had been tarnished and India was lately in the news for wrong reasons -- widespread corruption and weak government policies -- it is still attracting a lot of attention lately. Why?

Investment Thesis

Due to continued high inflation, the Reserve Bank of India (RBI) had kept the interest rates pretty high, which eventually hampered its growth. This, coupled with poor policy-making by the government, led to the depreciation of its currency by almost 30% in just 6 months.

But now, both the Indian government and the RBI believe that it is high time, and crucial policy changes are necessary. RBI has been cutting the interest rates, and recently cut the Cash Reserve Ratio (CRR) and Repo rate by 25bps each. The Indian government also raised the FDI limit in retail to 49%, in addition to many policy decisions recently.

Moreover, its inflation is at its 38-month low, and we can safely expect more interest rate cuts. This extra liquidity with Indian banks would trickle down in the economy, in the form of commercial and retail loans, which would eventually fatten the net interest income of Indian banks like HDFC Bank (NYSE: HDB) and ICICI Bank (NYSE: IBN), which have been consistently reporting stellar numbers.

Small is Big!

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(comparative stock returns over the last 10 years)

Although, both HDFC Bank and ICICI Bank are relatively small, it is their smaller size that allows them to grow at a rapid pace. Let’s compare the metrics of HDFC and ICICI along with biggies like Goldman Sachs (NYSE: GS), Wells Fargo (NYSE: WFC) and US Bancorp (NYSE: USB).

<table> <tbody> <tr> <td> <p>Bank</p> </td> <td> <p>Goldman Sachs</p> </td> <td> <p>Wells Fargo</p> </td> <td> <p>US Bancorp</p> </td> <td> <p>HDFC Bank</p> </td> <td> <p>ICICI Bank</p> </td> </tr> <tr> <td> <p>Annual Net Income</p> </td> <td> <p>$4.44 billion</p> </td> <td> <p>$15.86 billion</p> </td> <td> <p>$4.87 billion</p> </td> <td> <p>$0.977 billion</p> </td> <td> <p>$1.366 billion</p> </td> </tr> <tr> <td> <p>Debt/Equity</p> </td> <td> <p>604%</p> </td> <td> <p>116%</p> </td> <td> <p>113%</p> </td> <td> <p>89%</p> </td> <td> <p>228%</p> </td> </tr> <tr> <td> <p>PEG</p> </td> <td> <p>1.58x</p> </td> <td> <p>1.17x</p> </td> <td> <p>1.16x</p> </td> <td> <p>0.87x</p> </td> <td> <p>1.31x</p> </td> </tr> <tr> <td> <p>Net Profit Margin</p> </td> <td> <p>17.94%</p> </td> <td> <p>22.5%</p> </td> <td> <p>27.36%</p> </td> <td> <p>30.49%</p> </td> <td> <p>14.95%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>-NA-</p> </td> <td> <p>13.16%</p> </td> <td> <p>16.41%</p> </td> <td> <p>19.62%</p> </td> <td> <p>11.48%</p> </td> </tr> <tr> <td> <p>5-yr. EPS growth est.</p> </td> <td> <p>6.91%</p> </td> <td> <p>8.94%</p> </td> <td> <p>10.33%</p> </td> <td> <p>30%</p> </td> <td> <p>17%</p> </td> </tr> </tbody> </table>

(Source: Yahoo Finance, Finviz)

From the table, it’s not hard to conclude that HDFC Bank is clearly the pick. Not only does it enjoy the highest net margins, but it also sports the lowest debt/equity ratio, even less than the conservative Wells Fargo. Additionally HDFC Bank enjoys the highest ROE in the industry, and analysts estimate its EPS to expand by 30% for the next 5 years. This means in 5 years a $1,000 would turn into $3,712.

However ICICI Bank loses its luster due to high debt/equity ratio and mediocre net margins. Moreover, it has the least returns on equity, and its shares appear to be overvalued.

Tracking the Financials

HDFC Bank reported staggering results, with its quarterly net income surging by 30% YoY. According to Business Standard, “It was the 53rd consecutive quarter of 30% or more year-on-year growth in the bank's quarterly net profit.” Its net interest income grew by 22%, while its Non-Performing-Assets (NPAs) stood at just 1%. Owing to a high interest rate environment, its total deposits grew by 22%, while its Current and Savings Account (CASA) stood at an impressive 45.4%, clearly taking the Street by surprise.

Foolish Conclusion

Although ICICI Bank reported lower NPAs, its high leverage makes it a risky investment. Moreover, its shares have lost around 25% over the last 5 years, which is not impressive by any means.

HDFC Bank, however, has a track record of stellar performance, with little or no exposure to debt-ridden economies. Moreover, the Volcker rule, which restricts proprietary trading (in case there’s a conflict of interest) will hit Goldman Sachs and Morgan Stanley the hardest. Wells Fargo and US Bancorp are solid conservative banks, but the US economy is not expected to grow at a rapid pace. This limits their potential upside. As clear as it can get, I give HDFC Bank a Foolish Outperform Rating, but not ICICI.

PiyushArora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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