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HDFC Ltd: Borrowing big to stay in business - Outside View by Luke Verghese

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HDFC Ltd: Borrowing big to stay in business
Aug 14, 2012

It would appear that this company follows a real life high wire act in the conduct of its business

Epitome of corporate excellence

HDFC in market parlance represents the epitome of corporate excellence. Sewn together some 35 years ago and mothered by the revered late Hasmukhbhai T. Parekh of ICICI, it was for decades chaperoned around by his nephew Deepak Parekh who made the Corporation what it is today. Though he has since relinquished official duties he still continues to chair the board of directors of the company. (Incidentally, this is the only company that I have surveyed which concurrently has a managing director and a chief executive officer - what is the difference in work order between the two designations please? Is this an accommodation affair or what?) Any number of 'has been' imitator housing finance companies have been set up in its wake, but not one of them has been able to emulate the lodestar, and by a zillion at that. It towers over all other listed housing finance companies monitored and published in Capital Market Magazine - including second ranked LIC Housing Finance. Importantly, even though it is incorporated under Indian laws, and operates solely within its borders, the corporation makes do without a promoter management today.

As a matter of fact, such is its brand equity, that the foreign institutional Investors (FIIs) hold some 66.6% of the paid up equity of Rs 2.95 bn currently. Interestingly, the top two shareholders at year end are Aberdeen Asset Management Company Asia Ltd which held 7.7% of the total outstanding equity, and LIC with 5.6%. The top two shareholders at the preceding year end were completely different implying no less that there was a drastic churning in the company's shares and in the shareholding pattern during the course of the year. It also implies plenty of liquidity in the scrip. (This brings us to the point as to why no predator ever thought of making a bid for control of the company? Any bid is unlikely to succeed though, and for obvious reasons).

The current upper limit for shareholding by the FIIs in the corporation is 74%. In 2012 the board has passed an enabling resolution to increase the holding limit by FIIs to 100% of the paid up share capital. It now awaits shareholder approval. (This must be the first company operating in the Indian firmament to offer such a sweetheart deal to the investing class). The reserves and surplus at Rs 187 bn in end March 2012 dwarfs the paid up capital by a whole mile and then some more. The point to note here however is that the securities premium reserve alone amounted to Rs 60.4 bn out of the total reserves and surplus. In other words the management is very judiciously using its standing in the market to periodically hawk its new offerings of shares at considerable premiums to the face value to generate the necessary traction on the operations front. This is as they say money for jam. And it is just about the right way to go about doing business, in the very business sense of the term.

As the ten year summary highlights shows, the company has not issued any bonus shares in the last decade. The current mantra appears to be to push the pedal on the dividend outflow front, and forgo the issue of bonus shares. In 2011-12 the company paid out a dividend of Rs 18.89 bn (including tax), equal to 46% of its post tax profit of Rs 41.2 bn. The percentage dividend was only a shade lower in the preceding year. The dividend accelerated from 110% in 2002-03 to a high of 550% in the latest year. Fittingly enough, the corporation boasts of over 2,09,000 shareholders.

Germinating other nuggets

Along the way the company also germinated HDFC Bank -among the first of the new gen private sector banks to get off the ground in the early 1990's, after the government in a rather bold move at that point in time opened up this sector to private industry. HDFC holds a shade over 23% of the paid up equity of the bank, and this offspring like its parent has taken the high road to success under the more than able stewardship of long serving CEO Aditya Puri. HDFC and its banking offspring indulge in some judicious inter-se deals wherein the former under the loan assignment route sells individual loans to the latter as a part of the buyback option embedded in the home loan arrangement between the two. In 2011-12, HDFC sold individual loans valued at Rs 49.8 bn to HDFC Bank. That is a sizeable chunk of HDFC's total outstanding loan portfolio. In this manner HDFC gets to replenish its lending portfolio perhaps, and HDFC Bank gets an investment portfolio without having to work up a sweat. HDFC has also mothered 15 subsidiaries, with its shareholding pattern in them ranging from a high of 100% in nine offspring, and down to a low of 59.9% in HDFC Asset Management Company. But, I will expand on these siblings later on in this copy.

The financial highlights

As the snapshot of its financial highlights over the last decade shows revenues have grown from Rs 29.8 bn in 2002-03 to Rs 173.5 bn in 2011-12 - a jump of 483%.The profit after tax scooted up even faster - by 497% to Rs 41.2 bn. The total borrowings, consisting of term borrowings and deposits, grew most magnanimously by 498% to Rs 1,391 bn. But the loans advanced and outstanding at year end grew the most - by 548% to Rs 1,409 bn. However there appears to be no particular co-relation between the outstanding loans at year end and the gross revenues that it ponied up each year. (The real issue here is that the gross income also includes judicious dollops of other income which one cannot readily weed out each year in the ten year operational statistics, due to the lack of data). But in any event the gross income ranges from a low of 9.5% of loans outstanding in 2004-05, to a high of 13.7% in 2002-03, and ending with 12.3% in 2011-12. Neither is there any set pattern between the approvals of loans on the one hand, and the disbursements of loans on the other at each year end.

Earning its bread

Companies in the financing business have a different set of debt to equity ratios as compared to say manufacturing companies. This is because they primarily deal with dosh --period. They borrow money and then lend it out and try to make a decent enough margin between what they shell out and what they rake in. The trick of course for housing finance companies is to borrow real long term and to lend less long term at favourable rates and make money on the interest differentials. As stated earlier the company had borrowings of 1,391 bn at year end (a significant chunk of which consists of non convertible debentures, and borrowings from development institutions) and total loans advanced outstanding at year end of Rs 1,409 bn. The company has debited an interest outgo of Rs 108.7 bn to its P&L account which implies an average interest outgo of 8.6% against 7% in the preceding year. The interest earned on loans advanced on the other hand was around 11.8% against 10.5% previously. (These are but rough estimates but still it is illustrative of the trend). Thus the margin between what it earns and what it lends out comes to 3.2% against 3.5% previously. Curiously enough it made money in the interest income front on forex transactions, and it lost money on forex transactions on the interest outflow front.

Separately it earns interest on its cash resources and from its investments -both current and non-current. The total investments at year end amounted to Rs 122 bn against Rs 118 bn previously. The total interest earned on other investments including the cash management of mutual fund schemes and cash balances etc toted up to Rs 14.4 bn against Rs 10.3 bn previously. Separately it rustles up incomes under the guise of fees and other charges, and gains on forex transactions etc. Then there are still more incomes grouped under the head of profit on sale of investments and such like. If one were to add up all the other incomes it makes for a pretty picture alright. It totes up to a cumulative total of Rs 21 bn, against Rs 16 bn previously. On a percentage basis it adds up to a very impressive 37% of pre-tax profit against 33% previously. As a result one can garner where the margins are kicking in from.

The alacrity of it all

However it is the alacrity with which this company is run that is fairly evident in just one set of statistics. The current assets at year end (including cash and bank balances of Rs 54.7 bn) and some loans and advances amounted to Rs 261 bn. The current liabilities and some provisions at year end on the other hand was a humungous Rs 711 bn. That is to say what it owes to its creditors in its day to day subsistence is infinitely more than what is owed to it, and quite contrary to what students of accountancy are taught on prudent financial management. It reminds one of the Central government's ways and means position sort of. This is a situation which can be very firmly being referred to as skirting dangerously on very thin ice. And if this is the picture at year end then the picture in between must be a lot more colourful, in a manner of speaking. But HDFC being the company that it is-- is also able to get away with 'murder', or so one surmises. Such management of funds however implies considerable savings on working capital costs - read as interest charges.

If the company is performing the high wire act on the working capital front, then take a look at what its cash flow statement has on offer. It was out of pocket to the tune of Rs 237 bn on the cash flow front from its operating activities. This was mostly due to net loan disbursals of Rs 235.7 bn made during the year. But, still, that is a stupendous sum of money to be out of pocket of. The cash flow from investing activities was a damper as it basically involved putting down dough in mutual fund schemes and then pulling it out during the course of the year probably on a cum dividend ex-dividend basis or some such. But the amounts involved are humungous. The two way flow added up to Rs 3,816 bn. The company made good the deficit in cash generation through gross borrowing of Rs 239 bn by its financing activities. It also garnered small sums through the modicum of securities premium. In other words the dividend payout for the year was made possible by dipping into its additional borrowings! This bit of information folks is however off the record.

The burden of its siblings

And what do the stars foretell of its numerous siblings? It has appended the brief financials of 18 siblings, and they apparently include that of three step-down siblings. The top dog in every sense of the term is HDFC Standard General Insurance with a capital base of Rs 19.9 bn, total assets of Rs 339 bn (including investments of Rs 322 bn), total income of Rs 104 bn and a profit before tax of Rs 2.2 bn. This company also has accumulated negative reserves of Rs 10.8 bn. Next in the pecking order is GRUH Finance with a measly capital base of Rs 350 m, total assets of Rs 43.3 bn, revenues of Rs 51.4 bn, and a pre-tax profit of Rs 1.6 bn. Following close behind is HDFC Ergo General Insurance Company with a capital base of Rs 5.2 bn, total assets of Rs 23.8 bn, total income of Rs 10.5 bn, but sad to say it registered a pre-tax loss. The only other company of some significance is HDFC Asset Management Company with a capital base of Rs 327 m, revenues of Rs 6.9 bn, and a bumper pre-tax profit of Rs 3.8 bn.

All the other siblings are mere flea bites in a manner of speaking, including its US dollar denominated subsidiary Griha Investments, and the Singapore registered HDFC Asset Management Co. Singapore. What is significant to note here is that only two of the companies have declared a dividend-GRUH Finance and HDFC Holdings - with a total dividend outflow of Rs 600 m. Why HDFC pounced on these two siblings to pay any dividend at all is not known. Significantly, the company registering the highest margins, HDFC Asset Management, did not deem it fit to pay any dividend. The book value of HDFC's equity investments in its siblings totes up to Rs 26.2 bn and the total book value of its equity investments in its siblings and associates amounts to Rs 81.8 bn. Its single biggest equity holding is in HDFC Bank Ltd at Rs 55.5 bn, accounting for 68% of all equity investments in siblings and associates. (The HDFC Bank shares were acquired at an average price of Rs 141 per share on a face value of Rs 2 each). This is followed by HDFC Standard Life with a book value of Rs 15.4 bn. Separately it has equity investments - classified as non trade investments - in a number of listed and non listed Indian companies amounting to Rs 8.7 bn. That is to say the total equity investment amounts to Rs 90.5 bn. The total dividend income for the year is Rs 3.1 bn. That is not much of a return on investment, but it can mostly be attributed to the pricey acquisition price per share of HDFC Bank, and the lack of any compensation from its siblings.

The siblings -especially the big ticket ones - will in course of time start paying their tithes for sure, but even if they do it will not amount to much in the overall framework. Hence the other income sources that bring in the moolah today will continue to be the flag bearers in the morrow but their contribution cannot be predicted given the vagaries involved. Besides, the massive capital investment in its siblings and associates is dead wood in the sense that they will never be flogged.

But somehow the management makes it all possible. And, therein hangs a tale.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


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