We're raising HDFC Bank’s fair value estimate by 9% to INR 722.36 per share (or USD 35 per ADR), as we moderate our loan loss and operating cost assumptions for the bank, as its superior underwriting and tight cost management begin to reflect more tangibly in the firm’s bottom line numbers. We now project average growth in consolidated net income of 25% over our five-year explicit forecast, instead of the 21% assumed earlier. As such, the bank’s revenue continues to grow faster than costs as it reaps the benefits of scale. Furthermore, margins have begun to stabilize as loan growth and deposit growth remain resilient in the high teens.
We are also giving the bank an exemplary stewardship rating, as management has been able to grow its loan book at a compounded annual growth rate, or CAGR, of 28% between fiscal 2009 and 2013, while simultaneously bringing down loan losses from a peak of 2.3% experienced in fiscal 2009, to under 0.6% in fiscal 2013. As a result, both consolidated earnings and ROEs have shown considerable improvement since the financial crisis, and management has continued to return cash to shareholders in the form of high dividend payouts. While we continue to maintain our high uncertainty rating on our fair value estimate, we believe HDFC Bank is the best-in-class of all Indian banks under our coverage, and will continue to earn risk-adjusted margins higher than its peers for many years to come. We believe its narrow economic moat will remain intact even after several new banking licenses are issued by the government of India, as deposit-gathering and loan-underwriting are long gestation period businesses that require several years of experience on a steep learning curve. We recommend dividend and growth investors continue to hold this stock in their portfolio over a long-term horizon, and watch the growth story of the Indian middle-income households unfold.