HDFC: Will it maintain the sheen?

HDFC has reported a strong performance again with 20% growth in earnings and an improvement in operating margins for the June quarter. The company's interest income growth however, slowed down due to decline in investment income. HDFC's interest on core loans increased by 17% during the quarter.

(Rs m)	1QFY02	1QFY03	Change
Income from operations	6,104	6,809	11.6%
Other Income	236	230	-2.8%
Interest expense	4,624	4,975	7.6%
Net interest income	1,480	1,833	23.9%
Other expenses	355	375	5.7%
Operating Profit	1,125	1,459	29.6%
Operating Profit Margin (%)	18.4%	21.4%
Provisions and contingencies	30	30	0.0%
Profit before Tax	1,332	1,658	24.5%
Tax	191	285	49.4%
Profit after Tax/(Loss)	1,141	1,373	20.4%
Net profit margin (%)	18.7%	20.2%
No. of Shares (m)	120.1	121.7
Diluted Earnings per share*	37.5	45.1
P/E Ratio		13.7

HDFC's approvals and disbursements witnessed a commendable growth of over 30% during the quarter. In respect of individual loans, while approvals increased by 35%, disbursements grew by 37%. Individual loans account for over 70% of the total loan portfolio of the company. Lower interest rates, tax incentives and stable property prices have made housing more affordable. The company's robust retail growth was also a result of an increased network of offices and intensified marketing efforts.

On the liability side too, HDFC's deposits increased by 24% to Rs 97 bn during the June quarter. The total number of deposit accounts now exceeds 1.3 m. The company managed to bring down its cost of deposits, which is reflected from about 300 basis points improvement in operating margins. HDFC has issued Floating Rate Notes (FRN) in international markets for an amount equivalent to US$ 100 m. Overseas borrowings at comparatively lower interest rates seems to have brought down the company's average cost of funds to 10% from 12% in the comparable previous quarter. Steep decline in cost of funds, improved its core loan spread to 1.9% during the quarter from 1.5% in 1QFY02. Also, the company's stringent cost control measures enabled it to improve its cost to income ratio to 18% from 21% in the comparable previous quarter. However, with increasing competition from banks, the company's operating margins could come under pressure in the coming quarters.

Among other new developments, HDFC has entered into joint venture with Chubb Corp, US for general insurance. HDFC will hold 74% equity in the JV company and the balance will be with Chubb. The JV received the approval on July 18, 2002 from IRDA and plans to begin operations by September 2002. Initially, the company will launch its operations in 6 cities, Mumbai, Delhi, Bangalore, Hyderabad, Pune and Chennai. HDFC has not indicated the amount of investments in this JV.

At the current market price of Rs 618, HDFC is trading at a P/E of 14x 1QFY03 annualised earnings and price to book value ratio of 2.8x. HDFC's premium valuations are due to its ability to maintain strong growth rates and asset quality, despite stiff competition. However, its incremental investments in insurance are unlikely to generate returns in the near term, which could trim the overall growth of the company in coming years and consequently valuations. Average yield on investments declined to 16.2% in the June quarter from 18.3% in FY02 and 17.7% in 1QFY02.