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HDFC: Dwelling in profits! - Views on News from Equitymaster

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HDFC: Dwelling in profits!

May 2, 2006

Performance Summary
HDFC, the second largest mortgage financing institution in the country, has put to rest all speculations of a slowdown in home loan offtakes by posting a robust performance for the quarter and fiscal ended March 2006. While the institution registered yet another 30% YoY growth in approvals and 28% YoY growth in disbursements, a quantum leap in profit on sale of investments has added to its profitability. Margins and operating efficiency continue to be in line with HDFC’s past trend and corporate policy. The company has announced a dividend of Rs 20 per share.

Rs (m) 4QFY05 4QFY06 Change FY05 FY06 Change
Income from operations 9,523 12,358 29.8% 34,006 42,655 25.4%
Other Income 32 41 28.1% 95 129 35.8%
Interest Expense 5,039 6,773 34.4% 19,594 24,911 27.1%
Net Interest Income 4,484 5,585 24.6% 14,412 17,744 23.1%
Net interest margin (%)       3.3% 3.2%  
Other Expense 333 440 32.1% 1,752 2,113 20.6%
Provisions and contingencies 53 47 -11.3% 187 187 0.0%
Profit before tax 4,130 5,139 24.4% 12,568 15,573 23.9%
Tax 652 875 34.2% 2,202 3,000 36.2%
Profit after tax/ (loss) 3,478 4,264 22.6% 10,366 12,573 21.3%
Net profit margin (%) 36.5% 34.5%   30.5% 29.5%  
No. of shares (m)       249.1 249.6  
Diluted earnings per share (Rs)*         50.4  
P/E (x)         26.0  
* (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 4QFY06?
Fiscal incentive led growth: With the demand supply gap in the mortgage loan market narrowing, HDFC’s ability to sustain a firm trend in its incremental home loan sanctions and disbursements seems to be largely a fallout of the fiscal incentives available on the same. According to the market leader in home loans, ICICI Bank, the mortgage to GDP ratio in India has risen from 3% in FY05 to 6% in FY06 suggesting a 100% growth in this segment. Nevertheless, the continuation of fiscal incentives offered by the government on home loans, which effectively reduce the cost by 300 to 400 basis points, has kept the demand steady. This is despite the fact that HDFC has already raised its lending rates by over 100 basis points in the last fiscal. Nonetheless, with the funding costs rising at a faster pace, the pressures on the institution’s margins are evident.

Though not suggesting the culmination of the real estate boom, a consistent slowdown in HDFC’s disbursal to sanction ratio (81% in FY06) over the past couple of fiscals suggests that the housing loan segment is cooling off. This is despite the fact that HDFC has retained 30% YoY growth in approvals and 28% YoY growth in disbursements in FY06. Also, competition from banking entities and regulatory restraints imposed by the National Housing Bank (NHB) could be the other reasons for the apparent slowdown. HDFC, however, rules out the possibility of a ‘bubble’ in this segment on the premise that the demand for home loans in India is largely for habitation and not for investment purposes.

D/S ratio slides…
(Rs m) FY05 FY06 Change Cumulative
Disbursement 162,070 206,790 27.6% 931,030
Sanction 197,150 256,340 30.0% 1,124,320
D/S ratio 82.2% 80.7%   82.8%

Profitable investments: Although HDFC continues to take a cut in its fee income to compete in the increasingly competitive mortgage financing market, the profits garnered through the sale of investments seems to be hedging its other income. Also, the compromise in fees, 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 54% YoY at the end of FY06.

Breakup of other income
(Rs m) FY05 % of total FY06 % of total Change
Fee income 1,017 14.1% 675 8.4% -33.6%
Dividend 872 12.1% 1,079 13.4% 23.7%
Profit on sale of investments 1,741 24.2% 2,362 29.4% 35.7%
Lease and other income 1,048 14.6% 676 8.4% -35.5%
Income from securitisation 7 0.1% 14 0.2% 100.0%
Others 2,503 34.8% 3,235 40.2% 29.2%
Total other income 7,188   8,041   11.9%

Provisions getting heavier: As per the monetary policy for FY07, the provisioning requirement for commercial real estate loans has risen from 0.4% to 1.0% signaling the fact that the RBI is worried about the increase in real estate prices in India (risk weight on exposures to commercial real estate raised from 125% to 150%). In line with the RBI’s dictate, its counterpart NHB (regulatory body for mortgage loans) is also expected to hike the provisioning requirements, which will prove costly for HDFC.

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 (on the stock exchanges) its insurance subsidiaries (both life and non-life) by FY10.

What to expect?
At the current price of Rs 1,311 per share, HDFC is trading at 5.3 times our estimated FY08 adjusted book value. It may also be noted that the institution’s unrealised gains on investments, which we have not factored in, add Rs 239 per share to its book value.

HDFC’s US$ 500 m (Rs 21,650 m) zero coupon FCCBs will be due for equity conversion August 2006 onwards. The FCCBs have a conversion price of Rs 1,399 per share. Being zero coupon bonds, the FCCBs have been earnings accretive to HDFC. Also, despite the equity dilution, the conversion to equity would be book accretive as well, as it will be at a huge premium to the book value (FY06 book value is Rs 179 per share). 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.

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