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HDFC: Growing step-by-step

Jan 18, 2006

Performance Summary
Housing finance major, HDFC declared its results for third quarter and nine month period ended December 2005, posting yet another enthusing performance on the asset growth and net interest income front. While the institution sustained the trend of 30% YoY growth in assets and 20% YoY growth in bottomline, a quantum leap in dividend from subsidiaries has added to its profitability. Margins and operating efficiency continue to be in line with HDFC’s corporate policy.

Rs (m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Income from operations 8,469 10,519 24.2% 24,483 30,297 23.7%
Other Income 11 33 200.0% 63 88 39.7%
Interest Expense 5,086 6,397 25.8% 14,554 18,138 24.6%
Net Interest Income 3,383 4,122 21.8% 9,929 12,159 22.5%
Net interest margin (%)       3.4% 3.6%  
Other Expense 498 582 16.9% 1,420 1,673 17.8%
Provisions and contingencies 41 51 24.4% 134 140 4.5%
Profit before tax 2,855 3,522 23.4% 8,438 10,434 23.7%
Tax 495 677 36.8% 1,550 2,107 35.9%
Profit after tax/ (loss) 2,360 2,845 20.6% 6,888 8,327 20.9%
Net profit margin (%) 27.9% 27.0%   28.1% 27.5%  
No. of shares (m)       247.7 249.3  
Diluted earnings per share (Rs)*         47.3  
P/E (x)         24.2  
* (12 months trailing)            

‘Shelter’ing growth
HDFC, India’s largest housing finance company, with its strong brand equity and a market share of 21%, has an extensive reach with 203 branches spread across the country and abroad. HDFC’s strength over the years has been its core business of housing loans. Meanwhile, it also has tried to benefit from the retail reach of its banking subsidiary (HDFC Bank) and has entered into an agreement to source ‘home loan accounts’ from it. However, 70% of the accounts are sold back to HDFC Bank in the form of Pass Through Certificates (PTCs). Over the years, HDFC has emerged as a financial conglomerate by not restricting its ambitions to just housing finance but also venturing into new businesses like insurance, banking and asset management (mutual funds). It has recently set up a ‘real estate fund’. The HFC has grown at a scorching pace over the years despite competition from banking entities in the mortgage financing space.

What has driven performance in 3QFY06?
Disbursements - Signs of slowdown? Though not suggesting the culmination of the real estate boom, a consistent slowdown in HDFC’s disbursal to sanction ratio (78% in 9mFY06) over the past couple of quarters suggests that the housing loan segment is cooling off. The same may also be the fallout of the fact that as against banks, HDFC has gone ahead with raising home loan interest rates in the wake of rising cost of funds. The initiative has proved to be very benign for the institution i.e. the pressure on net interest margins (NIMs) that was witnessed in the last two quarters has eased (3.6% in 9mFY06 as against 3.5% in 1HFY06). Also, the institution has managed to retain consistency in terms of growth in approvals (32% YoY) and disbursements (30% YoY). While we do not see the HFC retaining the margins at the current levels, given that there are further pressures on cost of funds foreseen, we certainly believe that HDFC will continue to enjoy one of the highest margins in the sector in the longer term.

D/S ratio slides…
(Rs m) 9mFY05 9mFY06 Change
Disbursement 106,520 138,050 29.6%
Sanction 134,650 177,770 32.0%
D/S ratio 79.1% 77.7%  

Fee income - A profitable compromise? Although HDFC continues to derive value from its subsidiaries and sale of investments, the institution seems to be taking a cut on its fee income to compete in the increasingly competitive mortgage financing market. The same, although reducing the contribution of other income to its profitability, may prove to be beneficial if it helps the HFC regain its lost market share. It is also worth noting that HDFC’s unrealised gains on investments have grown by 46% YoY at the end of 9mFY06.

Breakup of other income
(Rs m) 9mFY05 % of total 9mFY06 % of total Change
Fee income 779 20.8% 407 12.2% -47.8%
Dividend 589 15.7% 765 23.0% 29.9%
Profit on sale of investments 1,409 37.6% 1,423 42.7% 1.0%
Lease and other income 904 24.1% 649 19.5% -28.2%
Income from securitisation 1 0.0% 1 0.0% 0.0%
Others 63 1.7% 88 2.6% 39.7%
Total other income 3,745   3,333   -11.0%

Benign FCCBs: The HFC raised US$ 500 m (Rs 21,650 m) through 5,000 zero coupon FCCBs in August 2005. The FCCBs have a tenor of 5 years and are convertible anytime after August 24, 2006 at a conversion price of Rs 1,399 per share, resulting into equity dilution to the extent of 6.5%. In case the holders do not opt for conversion, they would be paid a redemption premium of 4.6% YTM (yield to maturity). Being zero coupon bonds, the FCCBs would be earnings accretive in the event of non-conversion to equities. Even otherwise, as the conversion to equity would be at a huge premium to the book value (FY06E book value is Rs 180 per share), it is expected to result in significant book accretion as well.

Bullish on subsidiaries: Post the FCCBs issue, HDFC made additional investment in HDFC Standard Life Insurance (HSLIC), a 74% subsidiary, consequently raising the share holding of the corporation in HSLIC to 82%. This shows that HDFC continues to be bullish on the performance of the life insurance venture, which is yet to breakeven, as is the case with its other subsidiaries. It must be noted that as per IRDA norms, the institution has to list its insurance subsidiaries (both life and non-life) by FY10.

What to expect?
Given the buoyancy in the economy and the latent demand in the housing finance industry, HDFC seems to be well in track with its corporate policy of increasing RONW by 1% each year, sustaining operating efficiency and retaining asset quality. The HFC has maintained gross NPA levels at 1% of advances, despite the shift to the 90-day norm and provision coverage stands at a healthy 90%.

At the current price of Rs 1,144 per share, HDFC is trading at 4.6 times our estimated FY08 adjusted book value. Though not denying that the current valuations are expensive, we do acknowledge the fact that there is considerable value unlocking potential from a long-term perspective, which will be very remunerative to its shareholders.

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Aug 13, 2020 03:37 PM