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HDFC: Back on track - Views on News from Equitymaster
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HDFC: Back on track
Jul 16, 2005

Performance Summary
India’s largest mortgage financing company, HDFC, clocked a healthy 23% growth in its topline for 1QFY06, as compared to 5% in the corresponding quarter of FY05. The company witnessed 28% YoY growth in incremental disbursements during the quarter that increased its net interest income by 23% YoY. Although growth on the other income was stagnant, consistency in maintaining the cost to income ratio (6% - the lowest in the sector) has not impaired the HFC’s profitability (grew 21% YoY).

Rs (m) 1QFY05 1QFY06 Change
Income from operations 7,612 9,326 22.5%
Other Income 19 22 15.8%
Interest Expense 4,645 5,669 22.0%
Net Interest Income 2,967 3,657 23.3%
Other Expense 509 602 18.3%
Operating profit / (loss) 2,458 3,055 24.3%
Operating profit margin (%) 32.3% 32.8%  
Profit before tax 2,477 3,077 24.2%
Tax 431 604 40.1%
Profit after tax/ (loss) 2,046 2,473 20.9%
Net profit margin (%) 26.9% 26.5%  
No. of shares (m) 246.6 249.1  
Diluted earnings per share (Rs)* 33.2 39.7  
P/E (x)   22.3  
* annualised      

‘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 1QFY06?
Disbursements stabilise, margins improve:  A 30% growth in incremental approvals backed by 28% growth in disbursements enabled HDFC to stabilise its disbursement to sanction ratio at 83% during 1QFY06. This is a comfort factor, as this indicates the HFC’s success in arresting the loss of market share. Also, having increased the interest rates on home loans and garnered low cost deposits from banks and NHB, HDFC has improved its net interest margin (NIM) from 4.3% in 1QFY05 to 4.8% in 1QFY06. Going forward, the institution expects asset growth to continue at the rate of 25% per annum, although the possibility of new entrants (banks) poaching into its market share cannot be denied.

Income from operations (Rs m) 1QFY05 1QFY06 % YoY growth
Interest on loans 5,906 7,606 28.8%
Fee income 257 138 -46.3%
Dividend income 381 466 22.3%
Profit on sale of investment 138 187 35.5%
Income from leases 374 283 -24.3%
Other income 556 646 16.2%
Total 7,612 9,326 22.5%
Losing out on fee:  It is surprising to note that despite the fee income being directly linked to incremental disbursals, the HFC has witnessed a decline (46% YoY) in fee income during the quarter. The same could be attributed to stiff competition from the banking entities. With the HFC has largely relied on profit on sale of investments for its other income growth, the same may not be sustainable in future. It must be however, noted that HDFC has offered 9 m shares on sale in the IDFC IPO through which it is expected to make a profit of Rs 216 m during 2QFY06.

Excellent asset quality:  The quality of HDFC's loan portfolio continues to be excellent, with net non-performing loans at just 0.1% of total loan portfolio. The company advances loans up to 85% of the value of the property and retains the legal rights to the property till the loans are repaid. This entails it to a large margin of safety and it can sustain its burgeoning credit disbursal with relatively lower risk. The institution has made additional provisioning during the quarter to comply with the 90-day delinquency norm (effective from April 2005).

What to expect?
At the current price of Rs 887, HDFC is trading at a rich valuation of 5.7 times FY05 adjusted book value. Given that the HFC has time and again proven its capability to sustain growth, fundamentally, the business seems to be on a strong footing. With the capital adequacy ratio of 13%, the HFC retains the potential to capitalise on the growth prospects. The premium valuations can also be attributed to the value derived from its subsidiaries. Although we believe that HDFC will continue to be one of the strongest player in the mortgage finance industry, being a single – product entity and countering competition from peers may cause some hiccups in the times to come. At the current valuations, we believe that the risk-return matrix is highly skewed towards risks and to that extent, investors have to exercise caution.

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