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HDFC: Research meet extracts
Sep 13, 2005

In a recent research meet with the country’s largest housing finance company (HDFC), we got an insight into what lends the housing finance industry attractive growth prospects and how is HDFC geared up to capitalise on the same. Following are key excerpts of the research meet. Housing finance industry: All-encompassing
The Tenth Five Year Plan (2002-07) has estimated an outlay of Rs 7,263 bn to the housing sector, of which the contribution envisaged from public institutional sources is Rs 4,150 bn. Therefore, substantial contribution from private sector players would necessarily be required to tackle the growing housing shortage. Not to mention, the mortgage to GDP ratio in India that stands at a miniscule 3% is way behind that of the developed world (US 51%, UK 54%) and the other emerging economies (in Hong Kong and Singapore it is between 8% to 12%). Also, approximately 276 ancillary industries (including cement and steel) depend on housing industry for their survival and growth. Thus, the growth and maturity of the mortgage industry is imminent to nurture several other associated businesses.

HDFC’s customer profile: A paradigm shift
Being the oldest housing finance company in the country, HDFC has witnessed a paradigm shift in its customer profile over the decades. The institution currently has approximately 2.5 m customers, and the demographic profile has shifted from ‘high income’ to ‘middle and lower income’ groups, thus suggesting better affordability of mortgage loans. HDFC offers loans upto 85% of the asset value while the average loan to real value (market value of property) is pegged at 60%, thus offering sufficient margin of safety to the company. It is also interesting to note that the value of property to income ratio has dropped to 4 times in FY05 as against 20 times a decade ago. The company also witnesses prepayments to the tune of 8% to 10% (of the total loan outstanding) every fiscal. This again suggests better asset quality.

Prudent maintenance of margins
Besides enjoying one of the highest net interest margins in the financial sector (4.8% in 1QFY06) the HFC has also been very prudent in maintaining the same. It has 83% of its loans on a floating rate basis and the remaining 17% (that are on a fixed basis) are at a rate of 6.7% and above. HDFC has also recently gone for an FCCB issue of US$ 500 m. The 5-year zero-coupon bond will be convertible 2QFY07 onwards at a conversion price of Rs 1,399 per share. The cost of the bond comes to 4.6% that is at a considerable discount to the domestic borrowing rate.

HDFC also scores on the efficiency parameter of expense to asset ratio, which stands at 0.5% for the institution against the industry average of 2%. Also, of this 0.5%, 0.2% are variable costs. This leaves sufficient margin for the company to improve its profitability with higher asset growth.

Four prime objectives
HDFC leads the way amongst Indian corporates, to achieve high levels of targets, to add value to its investors. The same is manifested in 4 prime objectives of the company:

  • The company has been increasing its return on equity (28% in FY05) by 1% each year for the past decade and will continue to do so going forward.

  • It is a well-known fact that HDFC maintains the best asset quality in the industry with net NPA to advances less than 1%.

  • The HFC has a target of sustaining the cost to income ratio at less than 14%.

  • The targeted asset growth is atleast 25% per annum with an increment of 15 to 20 branches each year.

It is also essential to point out that despite being in a labour intensive industry, HDFC has historically enjoyed attrition levels of less than 3% and no senior management executive has exited the company in the last 10 years.

What’s our view?
At the current price of Rs 923, HDFC is trading at a rich valuation of 3.6 times our estimated FY08 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.

Company background
Spearheading the growth in Indian mortgage finance industry over the last two decades, HDFC has remained the largest housing finance company (HFC) in the country. Besides financing home loans in India, the HFC also has a distribution network in the Middle East. Consistency in its incremental home loan disbursal rates has helped it grow its outstanding loan book at a CAGR of 29% (higher than the industry average of 25%) over the last 5 years. The HFC however, has faced stiff competition from banks over the last ten years, resulting in loss of market share (from 40% in FY95 to 26% in FY05).

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