Raamdeo Agrawal on How to Identify the Next HDFC Bank
Brokers watch their screens during trading hours inside a dealing room. (Photographer: Abhijit Bhatlekar/Bloomberg News)

Raamdeo Agrawal on How to Identify the Next HDFC Bank

A large part of the shift from public sector banks to private sector banks yet to play out, and the best times are still ahead, according to Raamdeo Agrawal of Motilal Oswal Financial Services.

While speaking to BloombergQuint in the weekly special series Thank God It’s Friday, Agrawal said it’s important, while investing in the sector, to stick to the safe banks. Personally, he is only motivated to buy when he sees an “absolutely pristine” bank, housing finance company or NBFC which offers quality growth at a reasonable price.

Here is an excerpt of that conversation.

Hunt for Value

You have spoken extensively about value migration inprevious conversations. Where is that going to in terms of business and sectors over 5-10 years. Market dynamics are rapidly changing..which sectors could move up from current levels?

Value migration is a long story apart from a large story…. Back home, from public sector banks to private sector banks. We have only 25-30 percent banking in private sector banks and 70 percent with so called public sector banks.

‘Shift to Private Banks Playing Out’

So the large part of transition or shift has yet to be played out?

It will be other way round.. 70 percent will be private and 30 percent will be public.

The business from public sector bank to private sector bank is half played out according to you?

One third..and the best days are still ahead. Now there is a banking licence on tap and you don’t have to be a very blessed guy to get a licence. 20 licences have already been given and I don’t know how many guys will come and take it on top out of that in next 12 months or so.

Last time, out of the 10-15 licenses which were given, you have got one HDFC Bank, one Kotak Bank, IndusInd Bank, Axis Bank, ICICI Bank. These are all huge wealth creators. When HDFC Bank came, it got listed at Rs 40 bucks, 200 crore was the equity in 1996.

For Rs 800 crore you could buy the entire bank. Today the bank is worth Rs 3 lakh crore. These kind of opportunities are going to come up, and what HDFC Bank did in 20 years, these bank are going to do in 10 years.

I am concerned about where we are in the the asset cycle or bad loan cycle, because for a very long time we saw it play out in PSU banks and in the last few quarters we have seen it play out in the private sector banks as well. You have seen it with Axis Bank, you have seen it happen with ICICI Bank and word on the street is that in fact, it is going to get worse from here on for the next few quarters. Therefore how do you take stock. Are you fearful that a large part of the business these banks have been doing is fairly suspect at this point of time?

So I don’t have any view on that, you may have a better idea on that. The way we do it is that we buy the banks that don’t have troubled assets..that’s the only way to play the sector.

‘Stress’ful Times

But how do you know that because we have discovered in the last few quarters that they were pretending that they didn’t have it..

Yes, but that’s where the investing skills come in, we have to do some homework.

Then you’re only buying HDFC Bank which doesn’t have a book on that side at all.

Yes, why do I have to have a troubled book in my portfolio.

Okay..then we are know you are investing in HDFC...

See..the point is when you know the credit cycle is against you, you know that surprises are going to come. Even the banks don’t know how many accounts will go bad. So stay away. Somewhere there’ll be an opportunity for us to look at those banks. That’s not my style, to buy what is very cheap and that asset cycle has gone through. Fundamentally avoid these kind of situations.

So you have said two things to us so far, you’ve said that you are expecting a large part of the shift from public sector banks to private sector banks yet to play out, and on the other hand you are still telling us that many of these private sector banks might not be disclosing the real stress in their assets..stick to the safe banks..don’t buy now.

I am an investor, I have a choice, I am paying full price….I am paying price-to-book of 3 or 4. I have a choice where to invest and where not to invest..I don’t have to take responsibility of all the banks which are there. In a 17-stock or 15-stock portfolio, I need two banks and that is also not necessary. When I find an absolutely pristine bank, NBFC or housing finance company then only I will buy. It must be quality growth at reasonable price.

Even HDFC Bank currently stands under threat, because of all the technology changes we are seeing in the payments business. When do you judge, this has been a great investment but it’s time to get out.

We’re still not seeing signs of technology hurting them, technology is probably helping them. One has to remain open to the complete digital migration. Now it could be third level of value migration where from PSU banks it came to first generation private sector banks, and from first generation private sector banks the value can rapidly migrate very rapidly to second generation digital banks, but we have not yet seen signs of that yet. So when the migration happens it is a better business model. So you have to see... because it is a very large profit, in banking system you make around a lakh crore of profit.. so profit pool is very large. Private sector banks must be making approximately Rs 30-40,000 crore . Somebody has to show me that I have opened a large digital bank and it is making Rs 1000 crore of profit and it is looking to be the way to go and it is a threat to HDFC Bank.

A Small Business With 100x Return

Are you interested in..because I know sometimes you do unlisted equities….have you put money in some ‘fintech players’?

No, not fintech players but we just exited form AU Financiers, Jaipur. We bought at Rs 50-60 crore valuation, we put Rs 20 crore, which gave us 30- 35 percent. That was 6 years back. We sold it for Rs 5,000 crore..100x..that’s the power of private sector banks.

How did you find this company and how many more do you have on your list?

He walked in, he wanted to raise money and HDFC had given Rs 200 crore of credit line. That’s AU Financiers from Jaipur. You must meet Sanjay Agarwal sometime.

I have met many Sanjay Agarwals. Give us a sense of what you looked at in that company or what you saw in that company?

There was not much of a business. Of course, in financing if you underwrite very well, you do make money. The management..the person...a chartered accountant, young, passionate and with integrity.

What was he doing? A traditional lending business or online lending?

No..online lending..It was very small.. gross income of about Rs 10 crore and net profit of Rs 2 crore. We bought the whole thing in Rs 60 crore. So it is a leap of faith. We are celebrating success. We’ve had failures also. In private sector funding and banking there is a huge opportunity because this country is just exploding and the traditional banks, for whatever reason, are not able to reach out to the last mile. The branches are there but they are not going out of the branches. Even private sector banks broadly stop at branch level. All the dirty work or hard work at the client level is done by NBFCs. That’s why there is a lot of room for value creation.

Bajaj Finance: Missed Opportunity

For investors already invested in NBFCs, when do they get out? Do they get out or not? And for guys who haven’t got in and have lost out on that whole train, what do they do, ab kya kare?

Naye bande aayenge na. (New businesses will come in.) There are a lot of new ones that are coming in. I just told you about one or two. I missed Bajaj Finance. To start with Rs 30,40,50,100...I kept on being prompted by many people but I just missed it. We realised that at only Rs 2,000 per share. My other fund managers looked at it much earlier, maybe at Rs 200 or Rs 300. So as a (brokerage) house we’ve been buying. But if you ask me personally, I noticed it properly only when it went above Rs 2,500. From there it went to Rs 10,000.

There’s a saying.. ‘Don’t come in front of a speeding truck’. So if something is going at a very rapid pace...most people don’t know the power of compounding. When you grow at about, say 35 percent per annum, there are companies growing at 40 to 50 percent. Every two years it doubles. Four years it grows four times, in six years it grows eight times. Every two years they grow exponentially. So you cannot really calculate how much money they will make. So till that money-making is on at a rapid race don’t try to peg the price-to-book ratio, it doesn’t work like that. The market will respect the guys who have quality and growth. You will get to see from the quarterly results, here it is slowing down. Then you can get out, maybe at even 20 percent off the top. If you sell after it’s fallen 20 percent, you are better off than selling it at one-third the price.

You can read the entire interview with Raamdeo Agrawal here.

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