Morningstar Magazine - December/January 2015 - 30

Dispatches

Mead acknowledges that the low levels of interest
rates globally are a result of the highly levered
nature of borrowers.
As a result, he believes the reserve bank will be
on hold for the foreseeable future. "These
relatively low, risk-free rates will generate an
ongoing search for income by investors, as
our pension system evolves from accumulation
to retirement," he says.
Christine St. Anne is Morningstar Australia's online editor.

Value Play in Financials
ASIA

India
Barring any glaring missteps, Morningstar thinks
HDFC Bank HDB will continue to generate
high returns on equity and is favorably positioned
to leverage India's strong long-term economic
growth prospects.
Despite remarkable loan growth averaging about
35% annually the past 10 years, we like that
HDFC has managed to expand its deposit base at
nearly the same clip (29%), maintaining a low
cost of funds and upholding its profitability. Indeed,
with deposits-to-loans being around 1.15 times,
the bank has been able to produce substantial
net interest margins of 4.6% on average over
the last decade, and 3% on a risk-adjusted basis,
which is much higher than any of its peers.
We also believe HDFC has good cost-control
practices-with noninterest expenses consistently
below 55% of revenue, which means more money
flows to its bottom line. As the bank expands
its reach via opening more branches, in both urban
and rural areas, scale advantages will begin
kicking in, and overheads will stabilize at lower
cost-to-income levels of 50% going forward.
We believe there is still considerable scope for
long-term expansion and shareholder value
creation. The bank benefits from rising incomes

Morningstar December/January 2015

across India's middle and upper classes, which
have been the bank's target customer segments
for a long time. The bank's focus on salaried
individuals, with steadily rising incomes, and
giving loans mainly to existing clients within this
segment has allowed HDFC Bank to control
nonperforming loans at around 0.8% of loans,
which we think is quite commendable. As management suggested in an interview, the bank's
data-driven approach to understanding customer
behavior prior to giving out a loan has become the
gold standard in the industry.
We are increasing our valuation of HDFC Bank by
9% to INR 840.60 as we make downward
adjustments to our provision expense forecasts
and assume a slightly better cost-to-income
ratio. Our new fair value represents 3.7 times 2015
book value per share and 10 times our fiscal
2015 earnings estimate.

EBITDA margins contracted 890 basis points
to 50.5%, though some of this decline was anticipated due to mobile, marketing, and digital
content investments as well as integration of
UCWeb and AutoNavi. Although these trends are
slightly below our full-year expectations,
we believe these investments will protect the
firm's network effect as mobile commerce
adoption trends (which represented 35.8% of
retail GMV and 29% of total revenue) persist and
China's e-commerce market shifts to B2C.

There is no change to our $90 fair value estimate,
and we continue to forecast average annual
top-line growth exceeding 30% the next five
years and adjusted EBITDA margins returning to
the mid-50s as operating leverage increases
on a wider active user base. The shares appear
modestly overvalued at current levels, though
we don't see many immediate downside catalysts
over the near future.

Suruchi Jain is an equity analyst with Morningstar based
in India.

R.J. Hottovy, CFA, is an equities strategiest with Morningstar.

Alibaba's Results
Reinforce Wide Moat

New Rules Improve
Transparency

ASIA

China

Japan

The first quarterly update of Alibaba BABA as
a publicly traded company went a long way toward
reinforcing our wide moat rating and longerterm valuation assumptions. A number of key
metrics-including active users (up 52% to 307
million, including 217 million mobile users)
and gross merchandise volume growth (up 49% to
CNY 556 billion)-validated the strength of the
firm's network effect, which we believe will protect
Alibaba from increased China e-commerce
competition longer term. The firm is also making
good on its promise of increasing its mobile
monetization rate-to 1.87% in the quarter versus
1.49% last quarter-suggesting that it is extracting
a larger percentage of each mobile transaction,
a critical variable to our longer-term assumptions.

One of the main drawbacks of investing in
mutual funds for many Japanese, especially the
elderly, is that they're not the easiest product to
understand. Incomprehensible and difficult
language in prospectuses and annual reports has
kept customers away for a long time. The Japan
Investment Trust Association tried to fix the
problem in 2006 with new rules for prospectuses
and annual reports, but since then, the structure
of funds have only gotten more complicated.
More new rules will go into effect Dec. 1 to again
try to fix the unfavorable situation. Proposed
by JITA, these rules were prepared in accordance
with the revised Mutual Fund Law, which will start
to be enforced on Dec. 31. The law was revised

Morningstar Magazine - December/January 2015

Table of Contents for the Digital Edition of Morningstar Magazine - December/January 2015