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HDFC: Sustenance is the key
Oct 25, 2005

Performance Summary
Housing Development Finance Corporation (HDFC) declared its results for second quarter and half year ended September 2005, reporting no surprises either on the asset growth or the net interest income front. The HFC sustained 30% YoY growth in assets and 20% YoY growth in bottomline. While the institution continues to outperform the industry in terms of margins and operating efficiency, stagnancy on the other income front is increasingly posing a cause for concern.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 8,402 10,452 24.4% 16,014 19,778 23.5%
Other Income 33 33 -0.9% 52 55 5.8%
Interest Expense 4,824 6,072 25.9% 9,468 11,740 24.0%
Net Interest Income 3,578 4,380 22.4% 6,546 8,038 22.8%
Net interest margin (%) 3.4% 3.6%
Other Expense 460 536 16.5% 923 1,092 18.3%
Provisions and contingencies 46 48 4.3% 93 90 -3.2%
Profit before tax 3,105 3,829 23.3% 5,582 6,911 23.8%
Tax 624 840 34.6% 1,055 1,449 37.3%
Profit after tax/ (loss) 2,481 2,989 20.5% 4,527 5,463 20.7%
Net profit margin (%) 29.5% 28.6%   28.3% 27.6%  
No. of shares (m)       249.1 250.7  
Diluted earnings per share (Rs)*       36.3 43.6  
P/E (x)         21.0  
* (annualised)            

‘Shelter’ing growth
HDFC, India’s largest housing finance company, with its strong brand equity and a market share of 21%, has an extensive reach with 203 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 it. 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 2QFY06?
D/S ratio slides…
(Rs m) 1HFY05 1HFY06 Change
Disbursement 69,834 89,102 27.6%
Sanction 89,071 115,432 29.6%
D/S ratio 78.4% 77.2%  
Disbursements slow…but steady: Despite sustaining 28% YoY growth in disbursements and 30% YoY growth in approvals, HDFC was unable to retain its disbursements to sanction ratio (D/S). The slip in the D/S ratio, although marginal, suggests slowdown in the institution’s incremental credit disbursals. While the HFC has not divulged details of growth in the corporate loan portfolio (33% of advance book), the retail segment (home loans to individuals) grew by 26% YoY during 1HFY06. Despite the upward movement in interest rates, the HFC has not announced a lending rate hike. But the same may be expected going forward. The fact that HDFC 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 is also a comfort factor. Lower cost of funds (especially due to the zero coupon FCCBs) have already started reflecting on the HFCs net interest margins that have expanded by approximately 20 basis points over 2QFY05.

Fee erosion: HDFC continues to witness stagnancy on the fee income front. The fee income, despite being directly linked to incremental disbursals, has witnessed a decline (45% YoY) during the quarter. The same could be attributed to stiff competition from the banking entities. Income from dividend garnered from its subsidiaries continues to be the major source of other income for the HFC (needless to say that this is not bad in itself).

Breakup of other income
(Rs m) 1HFY05 % of total 1HFY06 % of total Change
Fee income 542 14.8% 297 7.9% -45.2%
Dividend 477 13.1% 625 16.7% 31.0%
Profit on sale of investments 693 19.0% 781 20.9% 12.7%
Lease and other income 1942 53.1% 2038 54.5% 4.9%
Income from securitisation 1 0.0% 1 0.0% 0.0%
Total other income 3655   3742    

Benign FCCBs: The HFC raised US$ 500 m (Rs 21,650 m) through 5,000 zero coupon FCCBs in August 2005. The FCCBs have a tenor of 5 years and are convertible anytime after August 24, 2006 at a conversion price of Rs 1,399 per share, resulting into equity dilution to the extent of 6.5%. In case the holders do not opt for conversion, they would be paid a redemption premium of 4.6% YTM (yield to maturity). Being zero coupon bonds, the FCCBs would be earnings accretive in the event of non-conversion to equities. Even otherwise, as the conversion to equity would be at a huge premium to the book value (FY06E book value is Rs 180 per share), it is expected to result in significant book accretion as well

What to expect?
At the current price of Rs 915, HDFC’s stock is trading at 3.7 times our estimated FY08 adjusted book value. In the event of conversion of the FCCBs into equity, the valuation of 2.8 times FY08E adjusted book would be relatively cheaper, albeit at the higher end of the valuation spectrum. While 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. Also, in the event of rising pressure on margins (not discounting the fact that HDFC enjoys one of the best margins in the sector), singularly relying on core business income may also prove to be risky going forward. At the current valuations, we believe that the risk-return matrix is skewed towards risks and to that extent caution is warranted.

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