HDFC's all-time low core valuations offer an interesting proposition

Trading at 1.3x price-to-book, the asking price of the mortgages business fails to capture some of the key developments

Housing Development Finance Corporation (HDFC Ltd) announced over the weekend that it had approved the deployment of Rs 47,000 crore towards affordable housing.

Given that HDFC is often viewed as a firm catering to the mid-to-upper market, this marks a significant change. Higher loans to the affordable housing segment mark its faster penetration into the space. The stock traded in the green on Monday, even though the rise was less than 1 per cent.

However, HDFC’s move to create the largest buffer for tentative asset quality pangs (from Covid-related disruption) of Rs 12,200 crore, and raise Rs 14,000 crore (maximum among NBFCs) to shore up capital adequacy to 19.5 per cent, has drawn a lukewarm response from the markets.  

What could add to investors’ woes is that the stock has remained a laggard despite its key subsidiary HDFC Bank (accounting for 27 per cent of overall valuations) gaining 12 per cent over the last three months.

The HDFC stock has dipped (down 1.5 per cent) during this period. HDFC Ltd is among the largest holding companies in the financial services spaces.

Along with its three marquee listed subsidiaries — the other two being HDFC Life and HDFC Asset Management Company — it draws nearly 45 per cent of value from these units, up from 39 per cent a year ago. HDFC Life has gained about 17 per cent, while HDFC AMC has shed 7 per cent during this period.

 

 

This leads to two key questions for investors — what lies ahead for HDFC’s bread-and-butter mortgage business, and whether they should remain positive on its core operations.

Valuations of HDFC’s core business have been on a downward trajectory for over 18 months, which touched a new low of 1.3x its trailing 12-month price-to-book, in August.

The prolonged de-rating of valuations in the NBFC space may not have spared HDFC’s core business. Further, rising caution over NBFCs’ developer or wholesale finance books may have prompted investors to take a wait-and-watch approach. 
 

Accounting for 26 per cent of HDFC’s loan book, pain in this segment has been steadily increasing since two years, touching a record gross NPA ratio of 4.1 per cent in the June quarter, up 142 bps year-on-year. Asset quality trend in its retail book fares better in comparison, but the gross NPA ratio (0.92 per cent) has been on the rise, even in this segment.

Though the recent equity raise may help the lender absorb potential loan losses, its ability to raise capital at dearth cheap rates remains the key solace for the stock and the reason for investors to hold their faith in its mortgage business.

Recently, the firm raised short-term funds at below 4 per cent and non-convertible debentures at below 7 per cent. Though bond market rates have eased during the past few quarters, rates locked in by HDFC remain unthinkable for any other player.

Being the leader of the pack should help take care of growth and help it remain ahead of the curve.

Suresh Ganapathy of Macquarie Capital says such a large holding company discount is unwarranted, and hence the current valuations are cheap and compelling for a quality franchise such as HDFC.