HDFC still stands on firm ground

Core business performance healthy, but high valuations limit near-term upside.

Despite a worsening macroeconomic scenario, India's largest housing finance company, HDFC, continues to deliver strong operational performance. Not surprisingly, even as its reported profit for the December 2011 quarter was a tad lower than Street expectations, the stock closed with a gain of 1.2 per cent at Rs 689.15 on the National Stock Exchange on a day when the markets were down by more than half a per cent. Although a few analysts are cautious regarding loan growth in the near term, the management is confident and has maintained an expectation of 18-20 per cent rise.

Vaibhav Agarwal of Angel Broking says, “Core operating performance for the December quarter is in line with expectations. However, loan book growth may slow down by a couple of percentage points.”

On the other hand, Kashyap Jhaveri and Aalok Shah, analysts at Emkay Global, who have maintained a ‘hold’ rating on the stock, remain unperturbed. They say in their report, “Loan growth came in at 21.2 per cent year-on-year. This has clearly shrugged off concerns over material slowdown in loan growth due to interest rates or property prices.”

The flip side comes from HDFC consistently delivering strong earnings growth over several quarters and maintaining high asset quality. So, its stock has traded at premium valuations. Any slippage on growth could, thus, impact the valuations.

While most analysts are positive on business prospects, they say the near-term upsides are limited due to rich valuations. For instance, over the past 10 years and in terms of valuations based on price-to-book value, the stock has traded at a premium of 20-98 per cent vis-a-vis the Bombay Stock Exchange’s Sensex. It is presently trading at an 80 per cent premium to the Sensex.

“Overall, we expect it to remain a steady performer. The current valuation of 4.4 times the 2012-13 estimated book value is very expensive. We believe there will not be any significant upsides from current levels and, hence, are ‘neutral’ on the stock,” says Agarwal. However, given that the interest rate cycle (a key driver of demand for homes) is at a peak and long-term demand for home financing is expected to remain healthy, investors with a two-three year perspective may consider the stock on declines.

Steady core business growth
Though HDFC’s reported net profit at Rs 981.25 crore was up just 10 per cent year-on-year, it was largely due to lower gains on sale of investments. Last year, HDFC had sold a two per cent stake in IL&FS, which boosted net profit in the December 2010 quarter. The absence of such gains in the recently concluded quarter has resulted in a 47 per cent year-on-year dip in profit on sale of investments at Rs 88 crore (Rs 87 crore in the September 2011 quarter). Adjusted for this, HDFC’s net profit is up 19 per cent year-on-year, in line with the historical trend.

What amused the Street was the strong growth in core business. Even as the real estate sector is going through a rough patch, HDFC managed to grow its net interest income by 18 per cent year-on-year in the December 2011 quarter, aided by strong loan growth of 21 per cent (adjusting for loans sold to HDFC Bank) and a rising interest rate environment. In fact, loan growth was robust across both individual and corporate segments. Advances to individuals posted a healthy growth of 20 per cent year-on-year, while the corporate loan book expanded 25 per cent over last year’s quarter.

Interestingly, loan approvals and disbursements continue to grow at a good pace, of 19 per cent, providing medium-term visibility. The management, too, has stuck to its expectation of 18-20 per cent in loan growth. Overall, analysts expect HDFC to show a compounded earnings growth of around 16 per cent over FY11-13.

Asset quality, margins
While the ability to maintain consistency in business growth has helped the stock command a premium over broader markets, strong asset quality has helped. For the December quarter, asset quality improved further. The ratio of gross non-performing assets (overdue for three months) was 0.82 per cent, as compared to 0.85 per cent a year before (on a sequential basis, the figure remained unchanged).

Conrad D'Souza, member of the executive management at HDFC, believes there are no pressure points on the asset quality front as yet, and hopes to improve it as well.

On the other hand, its interest on spreads remained stable at 2.27 per cent on a sequential basis, though marginally down by six basis points year-on-year. Indicating the firm has not been able to fully pass on the increase in interest costs to customers.

Likewise, its net interest margin (NIM) was 4.3 per cent for the nine months to December 2011 versus 4.4 per cent in the year-ago period. Analysts believe the margins may see some pressure in the interim due to the higher cost of funds. The management, though, expects to maintain NIMs within the narrow band of 4.2-4.3 per cent and spreads at 2.25-2.30 per cent.