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HDFC: Growing predictably

Oct 13, 2003

HDFC, the housing finance major, has reported September quarter results in line with expectations. It has announced a 22% net profit growth on the back of a 4% growth in topline on a YoY basis. The bottomline growth has been aided mainly by a fall in interest expenses (consequently improving operating margins). The improvement in operating margins has been achieved despite strong rise in operating expenses.

(Rs m) 2QFY03 2QFY04 Change 1HFY03 1HFY04 Change
Income from Operations 7,428 7,737 4.2% 14,457 14,996 3.7%
Other Income 18 21 21.7% 27 39 42.8%
Interest Expenses 4,966 4,764 -4.1% 9,942 9,553 -3.9%
Net interest income 2,462 2,974 20.8% 4,515 5,443 20.6%
Other Expenses 342 447 30.7% 672 832 23.9%
Operating Profit 2,120 2,527 19.2% 3,844 4,612 20.0%
Operating Profit Margin (%) 28.5% 32.7%   26.6% 30.8%  
Provisions for contingencies 42 55 32.1% 117 105 -9.9%
Profit before Tax 2,096 2,493 19.0% 3,754 4,545 21.1%
Tax 424 461 8.6% 710 835 17.7%
Profit after Tax/(Loss) 1,672 2,032 21.6% 3,045 3,710 21.9%
Net Profit Margin (%) 22.5% 26.3%   21.1% 24.7%  
No. of Shares (m) 121.7 244.4   121.7 244.4  
Diluted Earnings per share* (Rs) 27.4 33.3   24.9 30.4  
P/E Ratio (x)   15.9     17.4  

HDFC continues to maintain strong growth in disbursal (advances) of housing loans. During the September quarter, the financial institution (FI) has maintained a 30% growth in disbursals. This strong growth in advances has been maintained over the last 3-4 years and, considering the reach and reputation of HDFC, we believe that this growth rate is likely to be maintained in the medium term. This is especially because of the fact that housing finance industry is growing at a strong rate of 25%-30% and large players like HDFC are going to be the key beneficiaries of this robust growth. Having said that, we must also point out that despite the strong growth in advances, the company has not shown a commensurate rise in topline. This is mainly due to falling yields on advances.

However, falling interest rates have also helped the FI to reduce its interest expenses further, which has resulted in improvement in operating margins. Going forward as interest rates fall at a slower rate, we may observe a slowdown in the growth of HDFC's net interest income. This means that the FI's operating margins may sustain at the 1HFY04 levels. In our research report, we have assumed a 30% growth in HDFC's advances for FY04. We have also assumed a marginal fall in net interest margins of the FI to 3.7% from 3.8% in FY03.

HDFC was able to wipe out all of its NPAs in FY03. Gross NPAs stood at 0.9% of total advances at the end of FY03. The provisioning made in the June and September quarter may have been more of a precautionary measure as net NPAs are non existent at this point of time.

The stock is currently trading at Rs 528, a P/E multiple of 16x its annualised 2QFY04 earnings. HDFC has exhibited that it can hold its ground despite stiff competition in the housing loan segment. However, its valuations seem stretched considering that competition is fast catching up. At this point, we believe that investors seem to be factoring in the value of the FI's other business interests like insurance, banking and mutual funds.

However, a word of caution. Due to lack of credit offtake from the corporate sector, banks have been lending aggressively in the retail (especially housing loans) segment. This means that as banks increasingly put their house in order and get more and more customer-focused, we may see a faster erosion in HDFC's market share going forward. While the growth of the housing loan market seems robust, it is questionable whether HDFC will be able to maintain this strong growth in advances. If investors are valuing HDFC's subsidiaries, then they need to conduct thorough research and give realistic and practical valuations for the same.

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