Morningstar's equity research analysts undertake detailed company analysis to determine fair value estimates on listed companies. A fundamental component of our approach is the analysts' requirement to create a detailed financial model for each company we cover.
Our analyst teams adhere to one methodology, borne out of many years of reasoned debate and influenced by credible academic research. We strive for transparency and clarity, both internally and externally, to ensure our rigorous and independent approach is applied and communicated consistently.
In 2014, we conducted a thorough review of our valuation methodology and determined that we needed to make changes to our existing cost of equity and cost of debt methodologies. We believe these updates provide a sounder long-term basis for our average COE and COD assumptions, based on a building-block approach for each discount rate.
In some cases this will cause a change in our fair value estimate, or FVE. We believe our research will improve as a result of these changes.
Axis Bank
FVE increased by 35% to Rs 531 per share, or $43 per GDR, as we reduce our cost of equity to 12% from 14%. Our FVE represents 2.5 times 2016 book value per share and 14 times our fiscal 2016 diluted earnings estimate of Rs 37.54 per share.
Given that the growth and earnings potential of all Indian banks is closely linked to the Indian economy, we now assume a uniform 12% cost of equity across all our banks. We continue to evaluate them separately in awarding fair value uncertainty ratings, which lie in the high to very high range, given the high operating leverage and financial leverage with which banks operate in comparison with non-banks. We continue to believe Axis deserves a high uncertainty rating.
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ICICI Bank
FVE increased by 17% to Rs 327 per share, or $10.60 per ADR, as we reduce our cost of equity, or discount rate, assumption to 12% from 14%.
Our FVE estimate represents 2.2 times 2016 book value per share, and 13 times our fiscal 2016 earnings per share estimate. Since ICICI Bank’s performance is closely linked to the Indian economy, we consider the stock as having average systematic risk.
ICICI Bank's no-moat rating remains unchanged.
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HDFC Bank
FVE increased by 25% to Rs 1,050 per share, or $50.80 per ADR, as we reduce our cost of equity assumption, or discount rate, to 12% from 13%.
Our FVE represents 3.7 times 2016 book value per share, and 20 times our fiscal 2016 diluted earnings per share estimate of Rs 52.41.
Our core financial forecasts and outlook for the bank remain unchanged. We believe the bank has an exemplary track record of capital allocation decisions placing it in a strong position for future growth.
Overall, we maintain a positive outlook on the bank despite shares trading close to our estimate of intrinsic value.
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