HDFC, the largest housing finance company in the country, has reported a strong 22% growth in its bottomline for 1QFY05, while its topline has grown by over 5%. A fall in interest expenses (consequently improving operating margins) has been the main reason for the improvement in bottomline. The improvement in operating margins has been achieved despite strong rise in operating expenses.
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What is the company’s business?
HDFC is the largest housing finance company in the country with an incremental market share of over 20%. After venturing successfully into commercial banking, the company has set its sight on dominating the Infotech, mutual fund and insurance areas. The company has recently entered in to an agreement with its associate bank, HDFC Bank, in order to retail its products from the bank's branch network. This will go a long way in further extending the reach of HDFC across the country.
What has driven the performance in 1QFY05?
Sales: HDFC has managed to show an improvement in its topline growth as compared to the last quarter. This is primarily on account of a 27% rise in its cumulative advances in 1QFY05. We believe that interest rates on home loans may have bottomed out and due to lack of a fall in the same, the topline growth seems to have improved. In the short-term, this growth is likely to be maintained considering the expertise and track record of HDFC. Also, considering that the housing finance industry is growing at a strong rate of 25%-30%, large players like HDFC have benefited from this robust growth.
Operating margins: HDFC continues to reduce its interest expenses by leveraging on lower cost funds and this has helped it to improve its net interest margins strongly in 1QFY05. Falling interest rates have also helped the FI to reduce its interest expenses further, thus resulting in improved operating margins. HDFC continues to reduce its reliance on fixed deposits as a source of funding as they are relatively costlier (marginally) than other sources like term loans and debentures. Due to its excellent credit rating, HDFC is able to garner funds at very low interest rates. We expect operating margins to be maintained at these levels.
Net Profits: HDFC continues to show strong growth in its net profits. Due to its good asset quality, the institution does not have to make large provisions for NPAs. HDFC has also maintained its cost to income ratio, indicating that the company is able to limit its client acquisition costs. This may also be in part due to the fact that HDFC has entered into an agreement with HDFC Bank to sell its products from the branch network of the bank. This will help it to limit its operating expenses, thus helping maintain its operating margins.
What to expect?
The stock is currently trading at Rs 549, a P/E multiple of 16.5x its annualised 1QFY05 earnings. The company has done well to maintain its growth momentum over the last 2-3 years. However, with expectations of rising interest rates and strong competition in the segment, one needs to be cautious towards the prospects of the company. Its valuations seem stretched at the moment. It remains to be seen how the company is able to address the emerging concerns in the sector.
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