Kings of Capital – Covid Valuation

Saurabh Mukherjea raves about Kotak Bank and HDFC Bank. He even said – ‘We buy HDFC Bank every single day’ and added that he expects HDFC Bank to become 6x the current size. Woah.

Manish Chokani said “If India become a 5 Trillion $ economy, the largest bank might be 400 to 500 Billion $ (roughly 30 Lakh Crore INR).” As I write this, the Market Capitalisation of HDFC Bank is 5,55,000 Crore INR which means an opportunity of ~4.5x in 10 years?

I am not the narratives guy. So I will post a list of articles that I read to understand Banking and the top 2 Banks in India.

After reading these articles, more than anything else, I understood the following:

Good Asset Quality results in higher Net Interest Margin and lower NPAs. So the banks’ loan book keeps growing on higher ROE.

Please note that Asset Quality takes precedence over everything else – even Revenue Growth. Do not chase banks with high growth without evaluating the credit underwriting standards.

What makes them so lucrative? Size and the Returns they make on that size. How do banks scale up? Depositors’ TRUST.

After the Yes Bank collapse, HDFC Bank saw inflow of 80,000 crore of deposits from January to March 2020! Largest deposit growth (7.4 %) in 25 year history! Kotak Mahindra Bank said its deposits have grown by 11.7 % since December 2019. Some of the private banks such as IndusInd Bank and RBL Bank have witnessed erosion in their deposit portfolios.

Saurabh keeps talking about Kotak and HDFC Bank being the “high teen compounders”. What does he mean by that?

HDFC Bank share price gave 18.23% returns every single year in the last 10 years which is similar to their Return on Equity average of 10 years = 18.48%. So when you buy HDFC Bank shares, you can expect to get returns similar to their RoE figures in the long run.

Kotak Bank’s Price CAGR too is closely following their RoE numbers.

From whatever little I know of in stock markets, no one knows how to value a bank. Be it absolute valuation using DCF & DDM because the business model of banks is different from your regular companies or relative valuation using PE & PB because of differences in each bank. One can only look at the respective bank’s own historical averages to take some comfort. To me, relative valuation is not valuation and is only pricing but I do not know of any other method to decide the price I pay. And I want to be part of the Indian Banking story. So I decided to use PB ratio, which is the most commonly used ratio for Banks, to study the historical performance.

HDFC Bank trades at 4 – 5 times to it’s Book Value on an average in the last 10 years. Today, it is trading at 3.2x. Book Value = 315, Share Price = 1000.

Kotak Bank which used to trade at 3 – 4x book value in the early part of the decade and market re-rated Kotak in 2015 (ING Vysya merger?). Since then, it has been trading at 4 – 5x. Today it is trading at 3.75x. Book Value = 350, Share Price = 1330.

If you look at ICICI Bank, it has been trading at 2x Book Value in the last 10 years. It is clear that Market gives a premium to both Kotak and HDFC and more important is the fact that, the price to book value ratio average is constant at 4 – 4.5x over 10 years!

The Stock Price of these 2 has taken a hit because of the recent fall in banking stocks due to Covid. Market is expecting NPAs to shoot up because of lockdown and skeptical about demand when we restart the economy. In a normal scenario, one can expect returns to be in the range of 14 – 20% in these 2 banks when you buy at average price to book. In the Covid scenario? Given the uncertainties in the economy, how much can one pay for these 2 Banks?

A simple back-of-the-envelope template to calculate the adjusted book value of a bank.

Using the template to calculate Kotak’s Book Value with following assumptions:

Incremental Pre Provisions Operating Profit = 2% of Loan Book. In FY20, Kotak earned 4.56% of its loan book as PPOP. RBI has announced 6 month moratorium period for Covid and Kotak declared that 26% of borrowers by value at account level have availed moratorium as on 30-Apr-20. I have considered a worst case scenario of 50% drop in Operating Profits. Although Interest is accrued during moratorium, I would like to be on the safer side. Bank will eventually have to reverse it when the assets go bad.

Incremental Gross NPA due to Covid= 10% which is ~40% of the 26% who availed moratorium.

Loss Given Default (recovery rate on selling the NPA assets) = 50%

Zero Loan Book Growth for FY21 (very conservative)

Margin of Safety = 20% (To consider the Covid impact on subsidiaries and any errors in assumptions)

Adjusted Book Value for Kotak Mahindra Bank (all figures in Crores except per share values)

One can start buying Kotak Bank at or below 1000 which is close to 2.9x adjusted Book Value. The lowest level Kotak has traded in the last 10 years is 2.5x Price to Book Value in 2012. With an adjusted Book Value of 320 and 2.5x, the value is 800. Recommended to accumulate Kotak between 800 – 1000 levels. I don’t know if Kotak will trade at those levels. You might argue that my assumptions are conservative and we may not see 10% GNPA or 50% drop in Operating Profits. Agreed but if I buy at 1000 and Kotak doesn’t declare numbers anywhere close to my assumptions, I have the luxury of additional returns on reversion to mean (from trading at 3x BV to 4x BV).


  1. Incremental GNPA rising to 20%
  2. Bank making losses in FY21 which increases the additional Provision amount
  3. RBI policy change to waive off interest instead of moratorium or holiday period
  4. Bank failing to recover 50% from NPA assets
  5. Market doesn’t give any premium to Kotak over other banks

Given all these risks, one has to study the granularity of loan book or Kotak’s exposure to sectors most affected by Covid and also value the subsidiaries on an individual basis instead of taking the consolidated book value. Make different scenarios to test the sensitivity of the Book Value to various assumptions.

These assumptions and risks apply to HDFC Bank too. Kotak’s adjusted BV resulted in ~10% loss (350 to 320). HDFC Bank’s current BV is 315 and 10% loss will give us an adjusted BV of ~280. At 3x, value is 840. HDFC Bank traded at its lowest on March 24, 2020 at 2.5x BV which translates to 700 in adjusted levels. HDFC Bank has lost of some of its premium to Kotak off late. One reason I can think of is the successor issue. MD of the bank since it was founded in 1994, Aditya Puri, is retiring this October.

And remember – No one knows the impact of Covid on banks because NPA is a lagging indicator and we can’t forecast what 1 year from now will look like in unprecendented times like this. If you believe in the growth story of India, invest in the top banks based on your risk appetite. Valuation has to be dynamic and one has to evaluate the assumptions and asset quality periodically and on any material event.

Disclaimer – I am just a wannabe investor and not registered with SEBI. I make final buying decisions based on Price Action.

Published by Langval Capital

Reading between the lines | Investing | Personal Finance

One thought on “Kings of Capital – Covid Valuation

  1. One stop place to know about Kotak and hdfc bank which I am also planning to buy at lower levels as part of my core portfolio. Continue your great work in future.


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