HDFC Bank vs Kotak Mahindra Bank: Which Stock is Better?

The Indian banking industry has been stimulating economic growth of the nation for the last two centuries.

Despite this fact, India is still an underpenetrated market in terms of credit growth. This is primarily due to low levels of financial literacy.

For perspective, India's total credit outstanding is just 15% of the total value of all goods and services produced in the country. This is way below the average of 80-85% in countries like the US and UK.

Therefore, there is a lot of headroom for growth. It's expected that credit offtake would increase as more young people take the leap of entrepreneurship and create employment for more people.

This sets the stage for Indian banks to deliver high growth. If you're looking to invest in the Indian banking sector, you should look at banks which are growing their loan book consistently without compromising their credit quality.

In this article, we compare two such Indian banks, HDFC Bank and Kotak Mahindra Bank. Both have stood the test of different economic cycles and created value for their shareholders.

Let's get started...

Core operations aiding business growth

Banks run on a very simple business model. A bank's whole business model revolves around two essential functions: accepting deposits and disbursing loans. These functions are so integral to a bank's business model that without these there won't be any business for a bank.

Since these functions are so important, let's look at how HDFC Bank and Kotak Mahindra Bank have been progressing on these metrics.

Deposits

Deposits are the primary source of funds for a bank without which it cannot operate. This is because banks utilise the money it acquires through deposits to extend loans.

You see, banks depend a lot on people's money to grow their business. As per human psychology, people give their money only to those whom they trust. So, banks leave no stone unturned to woo their customers and gain their trust.

A burgeoning deposit base reflects people's trust in a bank and the reputation it enjoys among its customers.

The following table shows the deposit base of HDFC Bank and Kotak Mahindra Bank and its growth over the last five years.

HDFC Bank vs Kotak Mahindra Bank Deposits (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Deposit (in Rs m )
HDFC Bank	6,431,342	7,883,751	9,225,027	11,462,071	13,337,209
Kotak Mahindra Bank	1,555,400	1,912,358	2,248,243	2,604,002	2,788,714
Deposit Growth (%)
HDFC Bank	17.80%	22.6%	17.0%	24.2%	16.4%
Kotak Mahindra Bank	14.4%	22.9%	17.6%	15.8%	7.1%

Source: Equitymaster

HDFC Bank's deposit base is almost 5 times the deposit base of its peer Kotak Mahindra Bank. This difference exists primarily because of the loyalty HDFC Bank commands among Indians.

Also, HDFC Bank had a head start of 10 years when Kotak Mahindra Bank entered the banking business in 2003.

Both have been consistently growing their deposit base. However, HDFC Bank is slightly ahead.

HDFC Bank's deposit base has grown at double digit CAGR of 15.7% over the last five years. This compared to Kotak Mahindra Bank's average growth of 12.4% during the same period.

Advances

Now, let's look at the other side of the equation which is concerned with loans. Banks use their deposits to disburse loans or advances as they call it in banking parlance.

Ideally, a bank should be able to grow its loan book in-line with the growth of its deposit base.

However, a bank may tread cautiously and disburse less loans in times of economic distress and immune itself from extreme risk.

The following table shows the advances of HDFC Bank and Kotak Mahindra Bank and its growth over the last five years.

HDFC Bank vs Kotak Mahindra Bank Advances (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Advances (in Rs m)
HDFC Bank	5,854,810	7,000,338	8,692,227	10,436,709	11,852,835
Kotak Mahindra Bank	1,671,249	2,059,973	2,434,620	2,498,790	2,521,882
Advances Growth (%)
HDFC Bank	19.4%	19.6%	24.2%	20.1%	13.6%
Kotak Mahindra Bank	15.4%	23.3%	18.2%	2.6%	0.9%

Source: Equitymaster

For the last 5 years, HDFC Bank's advances have grown at a CAGR of 15.1% which is in line with the growth of its deposit base.

Kotak Mahindra Bank's advances haven't kept up pace with its growing deposit base. Its loan book has grown at a single digit CAGR of 8.6%.

However, if we consider the advances to deposit ratio, Kotak Mahindra Bank is ahead of HDFC Bank. Kotak Bank has an average advances to deposit ratio of 102% over the last five years. This means if Kotak received Rs 100 in deposit then it disbursed loans worth Rs 102.

Meanwhile, HDFC Bank has an average advances to deposit ratio of 90.8% during the same period.

An "interest"ing business model

The difference between the interest earned and interest paid is the bank's gross income, also known as net interest income (NII).

The following table shows the NII growth of HDFC Bank and Kotak Mahindra Bank over the last five years.

HDFC Bank vs Kotak Mahindra Bank Interest Income (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Interest income (Rs m)
HDFC Bank	732,714	852,878	1,051,607	1,221,893	1,285,524
Kotak Mahindra Bank	223,242	251,311	298,312	334,742	328,198
Interest expense (Rs m)
HDFC Bank	380,416	423,815	537,127	621,374	592,476
Kotak Mahindra Bank	114,575	124,668	151,866	159,007	129,665
Net interest income (Rs m)
HDFC Bank	352,298	429,063	514,480	600,519	693,048
Kotak Mahindra Bank	108,667	126,643	146,446	175,735	198,533

Source: Equitymaster

Here, Kotak Mahindra Bank trails behind HDFC Bank. Kotak's NII has grown at a CAGR of 12.8% over the last five years. This is compared to HDFC Bank's NII growth of 14.5% over the same period.

However, Kotak's cost to income, which is simply a ratio of interest expense to interest income, is lower than HDFC Bank.

Kotak Mahindra Bank and HDFC Bank's five-year average cost to income ratio stands at 47.3% and 49.7% respectively.

Net Interest Margin

Net interest margin (NIM) is net interest income divided by the total amount of loan disbursed by a bank.

The higher the NIM, the better it is for banks.

The following table shows the net interest margin of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Net Interest Margins (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net interest margins (%)
HDFC Bank	4.40%	4.60%	4.40%	4.20%	4.30%
Kotak Mahindra Bank	4.60%	4.30%	4.20%	4.90%	4.90%

Source: Equitymaster

In terms of margins, Kotak Mahindra Bank is faring better than HDFC Bank.

Kotak Mahindra Bank's five-year average NIM is 4.58% which is marginally higher than HDFC Bank's average NIM of 4.38%.

Non-performing assets (NPAs)

One thing that banks don't like is rising delinquencies as it hurts their profitability. Any loan for which the bank isn't earning interest for more than 90 days turns into a non performing asset (NPA) for the bank.

NPAs beyond a certain limit could drain a bank's fortune leading to its bankruptcy. Therefore, every bank keeps a check on its NPA numbers by having a due diligence framework in place. They check the creditworthiness of an individual or entity to whom the loan is being offered.

The following table shows the NPAs of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Net NPA

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net NPA (%)
HDFC Bank	0.3%	0.4%	0.4%	0.4%	0.4%
Kotak Mahindra Bank	1.3%	1.0%	0.8%	0.7%	1.2%

Source: Equitymaster

To start with, HDFC Bank and Kotak Mahindra Bank have a strong due diligence framework in place, and this is reflected in their NPA numbers which are the lowest in the industry.

HDFC Bank has consistently reported lower NPAs. The five-year average of HDFC Bank's NPAs is approximately 0.4% which is the lowest in the industry. It means that if HDFC Bank disburses a total loan of Rs 100 then Rs 0.4 doesn't come back to the bank.

On the other hand, the five-year average of Kotak Mahindra Bank's NPAs stands at a modest 1%.

Provisions

Every time a loan turns into an NPA, the bank must set aside a portion of its income to compensate for money lost. This portion is also called provisions in the banking parlance.

Provisions shrink the profitability of a bank significantly. It's one of the major expenditures for a bank in case it reports higher NPAs.

Have a look at the provisions of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Provisions (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Provisions (in Rs m)
HDFC Bank	120,689	164,749	202,547	245,985	297,797
Kotak Mahindra Bank	33,318	40,358	45,014	53,728	65,251

Source: Equitymaster

For the fiscal year 2021, Kotak Mahindra Bank's total provisions were 32.9% of its net interest income whereas HDFC Bank's total provisions were 43% of its net interest income.

HDFC Bank's provision seems to be in sharp contrast with its net NPA because the bank proactively does higher provisioning to fend off the burden of future defaults.

Net profit

The following table shows net profit figures of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Net Profit (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net Profit (in Rs m)
HDFC Bank	152,530	185,100	223,324	272,540	318,332
Kotak Mahindra Bank	49,404	62,010	72,041	85,934	99,902
Net Profit Growth (%)
HDFC Bank	19.4 %	21.4%	20.7%	22.0%	16.8%
Kotak Mahindra Bank	42.8%	25.5%	16.2%	19.3%	16.3%

Source: Equitymaster

HDFC Bank's net profits have grown at a CAGR of 15.9% in the last five years. Consistent growth in different metrics discussed above has translated into consistent growth in net profits too.

Kotak Mahindra Bank is marginally slower than HDFC Bank. Kotak Mahindra Bank's net profits have grown at a CAGR of 15.2% in the last five years. However, Kotak Mahindra Bank compensates for slow growth with higher margins.

The following table shows the net profit margins of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Net Profit Margins (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Net profit margins (%)
HDFC Bank	20.8%	21.7%	21.2%	22.3%	24.8%
Kotak Mahindra Bank	22.1%	24.7%	24.1%	25.7%	30.4%

Source: Equitymaster

Notice how both lenders not only have been reporting stable margins but expanding it every passing year.

Kotak Mahindra Bank's five-year average margin is 25.4% compared to HDFC's average margin of 22.2%.

Dividend Payout

Investors tend to invest in companies that pay dividends to their shareholders.

Dividend is the company's accrued profits distributed among shareholders. A company may pay a dividend when it doesn't have any immediate expenses to pay for.

The following table shows the dividend paid by HDFC Bank and Kotak Mahindra Bank to their shareholders over the last five years.

HDFC Bank vs Kotak Mahindra Bank Dividend Data (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Dividend per share
HDFC Bank	5.5	6.5	7.5	2.5	6.5
Kotak Mahindra Bank	0.6	0.7	0.8	0	0.9
Dividend Payout Ratio (%)
HDFC Bank	9.2%	9.1%	9.1%	5%	11.3%
Kotak Mahindra Bank	2.2%	2.2%	2.1%	0%	1.8%

Source: Equitymaster

HDFC Bank has paid an average of Rs 5.7 to each shareholder over the last five years. This is compared to Kotak Mahindra Bank's average of Rs 0.6 during the same period.

Another dividend metric that investors look at before investing in any company is dividend payout ratio. Dividend payout ratio determines how much dividend a company is paying from its earnings.

The five-year average dividend payout ratio of HDFC Bank and Kotak Mahindra Bank is 12.4% and 1.6%, respectively.

In this regard, Kotak Mahindra Bank has lagged behind HDFC Bank. This is because it's investing heavily in building its technological capabilities to enhance digital solutions.

Banking outlets and credit cards

Physical branches are still a preferred mode of accessing basic banking services, especially in rural areas. Therefore, they hold importance for a bank's growth.

HDFC Bank has a physical presence which is more concentrated in the rural and semi urban areas. As of March 2021, HDFC Banks had a total of 21,360 banking outlets across India with 78.5% of its banking outlets present in rural and semi urban areas.

Meanwhile, Kotak Mahindra bank has a larger physical network in the metropolitan cities like Mumbai, Delhi, etc. As of March 2021, Kotak Mahindra Bank had a total of 1,604 branches with 45% of total branches present in metropolitan cities.

Coming to credit cards, in 2020, RBI temporarily banned HDFC Bank from issuing new credit cards. But soon as the embargo was lifted in August 2021, the private lender came back strongly and issued record credit cards totaling 1.37 m.

HDFC Bank is the indisputable market leader when it comes to credit cards with total active credit cards in tune of 15.5 m.

Although Kotak Mahindra Bank trails behind HDFC Bank with only 2.6 m active credit cards, it's aggressively expanding its credit card base by issuing co-branded credit cards with popular brands such as PVR, Indigo, etc.

Investments and acquisitions

Increased internet penetration has made it convenient for users to access basic banking services via their mobile phones.

As a result, digital channels like internet banking, phone banking, etc. have emerged as a popular choice apart from physical branches. Several banks have been tying up with fintech companies to expedite the integration of technology and expand their customer reach.

While HDFC Bank is collaborating with fintech companies to tap their customer base, Kotak Mahindra Bank is focused more on strengthening its digital channels through in-house development.

As far as collaborations and investments of HDFC Bank are concerned, the bank has entered a strategic partnership with Paytm to leverage Paytm's digital platform and expand its reach in rural markets where Paytm enjoys good rapport with small merchants. This partnership will help the bank to burgeon its retail loan book.

The bank has also invested in Bengaluru based fintech platform Smallcase to benefit from increased participation in the capital markets.

Both the banks have picked up 9.9% stake each in Ferbine Private limited, a retail payment system floated by the Tata group.

Return and valuation ratios

Many analysts give a lot of importance to two return ratios while analysing banks. These ratios are return on equity (ROE) and return on assets (ROA).

ROE tells an investor how much profit a company generates from shareholders' capital. It's expressed as a percentage.

ROA tells an investor how much profit a company generates on its total assets. ROA is calculated as a ratio of net income to its total performing (generating interest income) assets. For banks, ROA of 1% is a benchmark and anything beyond that is considered excellent.

A key point to note here is that loans are registered as assets on the bank's balance sheet.

Take a look at the return ratios of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Return Ratios (2016-2021)

	2016-2017	2017-2018	2018-2019	2019-2020	2020-2021
Return on Equity (%)
HDFC Bank	16.6%	16.9%	14.5%	15.5%	15.2%
Kotak Mahindra Bank	12.8%	12.3%	12.4%	12.8%	11.8%
Return on Asset (%)
HDFC Bank	1.7%	1.7%	1.7%	1.7%	1.8%
Kotak Mahindra Bank	1.8%	1.8%	1.8%	1.9%	2.1%

Source: Equitymaster

On the ROE front, HDFC Bank outperforms Kotak Mahindra Bank. The five-year average ROE of HDFC Bank and Kotak Mahindra Bank is 15.8% and 12.4% respectively.

However, Kotak Mahindra Bank scores marginally higher than HDFC Bank on the ROA front. The five-year average ROA of HDFC Bank and Kotak Mahindra Bank is 1.7% and 1.9% respectively.

Coming to valuations, the following table shows the two most important valuation ratios, i.e. price to earnings (P/E) and price to book value (P/BV) of HDFC Bank and Kotak Mahindra Bank.

HDFC Bank vs Kotak Mahindra Bank Valuation ratios (2016-2021)

	P/BV	5 year average P/BV	P/E	5 year P/E
HDFC Bank	4.0	3.5	23.4	22.6
Kotak Mahindra Bank	4.5	3.8	39.02	30.6

Source: Equitymaster

Both the banks are trading at a higher valuation than their 5-year average. However, when seen relatively, Kotak Mahindra Bank is trading at a higher valuation than HDFC Bank primarily due to higher margins and lower cost to income ratio.

Impact of Covid 19

A nationwide lockdown to curb the spread of the pandemic brought the Indian economy to a screeching halt. With the economy in shackles, banks were up for some hammering.

However, the Reserve Bank of India (RBI), put their foot in the door and saved the banks from drowning. Had it not been for RBI intervention, banks would have bled more than they did.

For the first two quarters of the fiscal year 2021, although the banks reported lower NPA figures, they also reported flat or negative revenue and profit growth. As the restrictions eased up and the festival season dawned upon the country, demand came roaring back.

Home loans were the major demand driver in the retail category due to lower interest rate regime. In the wholesale category, banks financed the increased working capital requirements of businesses.

Thanks to this revived demand, Indian banks closed the year on a healthy note.

Future prospects

A large part of India is still credit averse. A lot of people in India see loans and credit in a bad light.

As a result, India lags behind developed nations in terms of credit. India's total outstanding loans to gross domestic product (GDP) is just 15% compared to 80-100% in its western counterparts.

So, India has a lot to cover and there is a lot of headroom for growth for Indian banks. Let's look at some of the possibilities of how India may achieve higher credit growth and financial inclusion.

To start with, as companies adopt China plus one strategy, they see India as an obvious alternative. The Indian government too is looking at this opportunity to make India as the biggest manufacturing hub in the world.

Small and medium enterprises (SME) would play a crucial role in making India a manufacturing hub. Hence, SME financing could be a great opportunity for banks to grow their loan book.

Also, it's expected that people currently working in the agriculture sector would shift to the manufacturing sector once the sector starts growing. Therefore, rural markets would present a new wave of growth for banks to ride on.

However, financial literacy remains a big challenge. Banks must tackle this issue if they wish to leverage the untapped potential of the rural market.

Finally, due diligence remains a key for any bank's success. Any bank which follows a quality due diligence framework and keeps a check on its bad loans will emerge as a leader. HDFC Bank and Kotak Mahindra Bank are perfect examples of this.

To sum up, HDFC Bank and Kotak Mahindra Bank, being the top players in the industry, are poised to grow as the overall industry grows.

Which is better?

If we compare the two banks on credit growth, HDFC Bank is easily ahead of Kotak Mahindra Bank by a huge margin.

However, on the net margin front, Kotak Mahindra Bank scores higher than HDFC Bank.

As far as the credit quality is concerned, both banks have been successful in maintaining their NPAs at the lowest in the industry primarily due to a strong due diligence framework in place. However, when seen relatively, HDFC Bank scores a point here.

If we were to conclude with a better bank on the above three metrics, both banks seem to have robust financials and a strong balance sheet.

However, if we compare them on valuation ratios, HDFC Bank is trading at a discount to Kotak Mahindra Bank.

Though this analysis might have made things easier for you, we strongly recommend you to check the fundamentals and valuations of these companies on your own.

Still confused which is better?

Use Equitymaster's compare company tool for a detailed comparison between HDFC Bank and Kotak Mahindra Bank. You can also use this tool to draw a detailed comparison of any two companies of your choice.

HDFC Bank vs Kotak Mahindra Bank

You can also compare both the companies with their peers.

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For a more detailed analysis, check out the financial fact sheet of HDFC Bank and Kotak Mahindra Bank.

You can also check out the latest quarterly results of HDFC Bank and Kotak Mahindra Bank.

Since stocks from the banking sector interest you, check out Equitymaster's powerful stock screener to find the top banking companies in India.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...