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HDFC: No aberration! - Views on News from Equitymaster

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HDFC: No aberration!
Oct 19, 2006

Performance summary
Defying investor concerns about a slowdown in mortgage lending, the largest mortgage lending institution in the country, HDFC, announced robust results for 2QFY07, in line with that clocked over the past several quarters. While there are no aberrations on the asset growth and margin fronts, growth in other income is also enthusing. The buoyancy in profits has been aided by lower provisioning and control over operating expenses.

Rs (m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Income from operations 10,452 14,468 38.4% 19,777 26,925 36.1%
Other Income 33 95 193.5% 55 124 126.2%
Interest Expense 6,072 9,137 50.5% 11,740 17,151 46.1%
Net Interest Income 4,380 5,331 21.7% 8,037 9,774 21.6%
Net interest margin (%)       3.6% 3.7%  
Other Expense 536 686 28.0% 1,092 1,353 23.9%
Provisions and contingencies 48 39 -18.8% 90 76 -15.6%
Profit before tax 3,829 4,701 22.8% 6,910 8,469 22.6%
Tax 838 1,020 21.7% 1,447 1,820 25.8%
Profit after tax/ (loss) 2,991 3,681 23.1% 5,463 6,649 21.7%
Net profit margin (%) 28.6% 25.4%   27.6% 24.7%  
No. of shares (m)       249.3 249.6  
Diluted earnings per share (Rs)*       43.8 53.3  
P/E (x)         27.4  
* (12 months trailing)            

‘Shelter’ing growth
HDFC, India’s largest housing finance company, with strong brand equity and market share of 21%, has an extensive reach with 228 branches 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 2QFY07?
Riding the consumption story: With mortgage at mere 4% of GDP and shortage of 19.4 m dwelling units (source: HDFC’s latest presentation), HDFC continues to cash in on the potential demand in the Indian mortgage industry. This is despite the fact that while the average annual income of an Indian household has grown from 0.36 m in FY05 to 0.45 m in FY06 (growth of 25% YoY), the average property value has risen from Rs 1.7 m to Rs 2.4 m (growth of 41% YoY) during the same period. The same has been further aided due to the effective cost of home loans being brought down from 8.2% in FY02 to 5.7% in FY06, due to the fiscal incentives.

While the retail loans continue to comprise a major 68% of HDFC’s advance book, the big-ticket corporate loans seem to be growing at a faster pace. Disbursements in respect of individual loans and corporate loans grew by 25% YoY and 32% YoY respectively in 2QFY07. While on one hand a 28% YoY growth in incremental approvals backed by 27% YoY growth in disbursements suggests consistency in the HFC’s performance over the corresponding quarter of FY06, on the other hand, no perceptible change in the disbursal to sanction ratio defies concerns over slowdown. The net interest income of the HFC continues to be buoyant due to higher yields on assets. Also, despite the higher cost of funding, with the higher yield on assets now filtering in, we see stability in net interest margins in the coming quarters. HDFC raised FCCBs in FY06 and has indicated that it will incrementally resort to long term funding in the near future as against short term bank borrowings, the latter being available at steep costs.

No signs of slowdown…
(Rs m) 1HFY06 1HFY07 Growth
Current year      
Approvals 115,432 147,290 27.6%
Disbursements 89,102 112,801 26.6%
D/S 77.2% 76.6%  
       
Cumulative      
Approvals 983,412 1,271,606 29.3%
Disbursements 813,345 1,043,835 28.3%
D/S 82.7% 82.1%  

Dividends fill up the void: HDFC’s fee income once again fell, however, this time much lower than that witnessed over the past couple of quarters, thus suggesting that the pressure on processing income has reduced. The HFC has been taking a cut in its fee income to compete in the increasingly competitive mortgage financing market. However, the dividend income from its subsidiaries and profits garnered through the sale of investments have more than made up for this. It is also worth noting that HDFC’s unrealised gains on investments have grown by 43% YoY at the end of 1HFY07.

Breakup of other operating income
(Rs m) 1H06 % of total 1H07 % of total Change
Fee income 296 7.9% 232 4.9% -21.6%
Dividend & other incomes 3,454 92.1% 4,509 95.1% 30.5%
Total other income 3,750   4,741   26.4%

Capital concerns addressed: As per the monetary policy for FY07, the provisioning requirement for commercial real estate loans has risen from 0.4% to 1.0% signaling the fact that the RBI is worried about the increase in real estate prices in India (risk weight on exposures to commercial real estate raised from 125% to 150%). In line with the RBI’s dictate, its counterpart NHB (regulatory body for mortgage loans) also hiked the provisioning requirements, which proved costly for HDFC. However, HDFC’s comfortable CAR of 13.5% in 1HFY07 relieves it of capital raising requirement in the short term. Further, net NPAs of 0.2% keep the asset quality provisioning requirements low for the institution.

What to expect?
At the current price of Rs 1,460, the stock is trading at 6.3 times our estimated FY08 standalone adjusted book value (4.5 times FY08E consolidated adjusted book value). The investment value per share is Rs 128 (at book value). Its unique business model (sales through DSAs and arrangement with HDFC Bank) enables HDFC to sustain the lowest cost to income ratio (13% in 1HFY07) and enjoy operating leverage. While the valuations are reasonably stretched on a standalone basis, willingness to hold on for the longer term may accrue benefits to investors, as the consolidated value gets unlocked.

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