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HDFC: Temporary blips - Views on News from Equitymaster

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HDFC: Temporary blips

Jul 25, 2007

Performance summary
  • Interest income grows 51% YoY on the back of 25% YoY growth in advances and higher lending rate.

  • Net interest margin decline to 3.3%, from 3.5% in 1QFY07.

  • Other income fails to show any growth.

  • Bottomline grows by 26% YoY aided by lower provisioning, despite higher tax outgo.

  • Net profit margins decline from 26% to 22%.

(Rs m) 1QFY07 1QFY08 Change
Interest income 11,419 17,241 51.0%
Interest Expense 8,014 12,451 55.4%
Net Interest Income 3,405 4,790 40.7%
Net interest margin 3.5% 3.3%  
Other Income 1,065 1,062 -0.3%
Other Expense 613 722 17.8%
Provisions and contingencies 90 80 -11.1%
Profit before tax 3,767 5,050 34.1%
Tax 799 1,322 65.5%
Effective tax rate 21.2% 26.2%  
Profit after tax/ (loss) 2,969 3,729 25.6%
Net profit margin (%) 26.0% 21.6%  
No. of shares (m) 249.5 253.0  
Book value per share (Rs)* 189.0 233.0  
P/BV (x)   8.4  
* (Standalone book value as on 30th June 2007)

India’s largest HFC
HDFC, India’s largest housing finance company (HFC), with strong brand equity and market share of 21%, has an extensive reach with 237 branches (FY07) 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 the latter. 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 1QFY08?
Margins losing ground: With a host of PSU, private sector and foreign banks and NBFCs offering home loans these days, mortgage loan has become a commoditised product. Profitability from the same solely depends upon the pricing power of the lender. A 300 to 400 basis point rise in mortgage lending rate, in a year, also leaves little headroom for aggressive pricing. The statistics of mortgage finance contributing 6% of India’s GDP in FY07 from 3% in FY05 may appear enthusing. However, this does not demean the shortage of 45 m dwelling units as per the 11th 5-year plan (5 m backlog, 22 m in rural and 16 m in urban areas: Source HDFC). HDFC continues to cash in on the potential demand in the Indian hosing finance industry. However, despite the fiscal incentives, the same has become very expensive in the last 9 months.

The spike in home loan interest rates during this period, which has not been commensurate to the rise in income levels, has had a lagged impact on the institution’s incremental approvals which have grown by 29% YoY. The disbursal to sanction ratio has also slowed down to 73% from 77% in 1QFY07, possibly due to higher propensity for slippages in a high interest rate scenario. Also, despite the higher yield on assets, HDFC’s net interest margin has witnessed a contraction of nearly 20 basis points YoY (40 basis points QoQ). Having said that, with HDFC having raised equity capital through a preferential allotment in this month, the institution will be able to repay its high cost borrowings in the coming quarters and improve its NIMs.

Loan book break up…
  1QFY07 1QFY08 Change
Individuals 320,367 395,236 23.4%
% of total 67.8% 66.9%  
Corporate Bodies 144,387 181,635 25.8%
% of total 30.5% 30.8%  
Others 7,978 13,554 69.9%
% of total 1.7% 2.3%  
Total loans 472,732 590,425 24.9%

The fact that HDFC saw a faster accretion of corporate customers to its loan book (against retail) must have also led to the institution falling short of bargaining power (in interest rates) against these customers. The growth of 25% YoY in loan book is in line with the sector average and the institution’s targets. This is also higher than our estimate of 23% YoY growth in loan book in FY08.

Other income - Hedged by surpluses: HDFC’s other income remained flat in 1QFY08 over that in 1QFY07. The 44% growth in fee income, however, suggested less pressure on processing income, due to the higher pricing power over the last couple of moths. Having said that, while the institution has been able to grow its fee income (linked to incremental disbursements) at rates commensurate with that of the underlying mortgage product, the over-reliance on treasury income has not borne fruit in this quarter. Despite the fall in income from sale of investments, the HFC’s other income remained hedged, thanks to a 233% YoY growth in surpluses from cash deployed in cash management schemes of mutual funds. The same may, however, not be sustainable going forward. The unrealised gains on investments at the end of June 2007 rose by 48% YoY.

Breakup of other income
(Rs m) 1QFY07 % of total 1QFY08 % of total Change
Fee income 71 6.9% 102 9.9% 43.7%
Surplus from deployment in MFs 72 6.9% 240 23.4% 233.3%
Profit on sale of investments 510 49.2% 260 25.3% -49.0%
Dividend & other incomes 383 37.0% 425 41.4% 11.0%
Total other income 1,036   1,027   -0.9%

Resource constraints addressed: HDFC’s capital adequacy ratio (CAR) stood at 13.8% in 1QFY08. The corporation has received an amount of Rs 31 bn through the preferential allotment of equity shares to Carlyle Group and Citigroup Strategic Holdings, Mauritius in this month, which will further strengthen its balance sheet. Also, gross NPAs of 0.9% and net NPAs of 0.2% keep the asset quality provisioning requirements low for the institution.

What to expect?
At the current price of Rs 1,960, the stock is trading at 4.0 times our estimated FY10 adjusted book value. At the 1QFY08 book value adjusted for unrealised gains on investments (Rs 656 per share), the price to book value multiple is 3 times. The investment value is Rs 130 per share (at book value). HDFC’s unique business model (sales through direct selling agents and arrangement with HDFC Bank) enables it to sustain the lowest cost to income ratio (12.3% in 1QFY08) and enjoy operating leverage. The management has indicated that the timely lending rate hikes will ensure that its spreads are protected. However, this may have an impact on its asset growth.

In search for new avenues of growth, the institution is now targeting smaller cities, where real estate prices have risen, but not as much as the rise witnessed in metros and other large cities. HDFC's ability to profitably sustain market share in mortgage portfolio and enhance its fee income share will determine its growth going forward. Notwithstanding the fact that our concerns with respect to quality of real estate loans were vindicated in FY07, we see improving prospects for the HFC, given its risk averseness, in the medium to long term. We maintain our view on the stock.

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