Macquarie, HDFC at war over accounting practices

Brokerage says earnings inflated, but mortgage lender rubbishes charges

Foreign brokerage Macquarie on Thursday downgraded the HDFC stock, saying the country’s biggest mortgage lender had used “aggressive accounting practices” to inflate earnings – a charge HDFC later said it “completely disagrees” with.

In a report titled ‘The last bastion falls’, Macquarie analysts downgraded their rating on HDFC stock to “underperform” from “outperform” citing a likely structural de-rating of the lender as its quality of earnings and return on equity (ROE) are being driven by its corporate book and aggressive accounting practices.

Macquarie has slashed its 12-month price target on the stock by 30 per cent to Rs 550. Shares of HDFC on Thursday ended 1.63 per cent lower at Rs 644.6 on the Bombay Stock Exchange (BSE). HDFC warrants fell 16.14 per cent to Rs 42.85. These have dropped nearly 20 per cent in the past two trading sessions.
 

MACQUARIE'S TAKE ON HDFC

• Structural de-rating likely 
• ROE driven by corporate book
• Accounting practices used to inflate earnings and ROE
• Regulatory changes underestimated by investors
• Inadequate disclosures

HDFC's response 

• Completely disagrees with Macquarie report 
• HDFC not just a housing company but also a financial holding company
• True share of profit of subsidiaries not considered as part of HDFC's profits
• Profits of HDFC would be higher by Rs 1,340 cr if subsidiaries' profits are included
• Adjustment for zero-coupon bonds is not new

“Mortgage profitability is declining structurally and regulations have become adverse. All this would make it tougher for HDFC to sustain its super-normal multiples/valuations,” said Suresh Ganapathy and Parag Jariwala, analysts at Macquarie in their report. “Though near-term catalysts are absent, the de-rating call is more a longer-term view as the stock appears fundamentally overvalued.”

“Over the past two years, HDFC has been adopting aggressive accounting practices bypassing provisioning through reserves and also making adjustments for zero-coupon bonds through reserves,” they said. “We believe FY11 and FY12 earnings are overstated by 38 per cent and 24 per cent, respectively, and reported ROE would have been 600 and 400 bps lower at 16 per cent and 18 per cent, respectively, if the adjustments had been made through the P&L. In our view, earnings growth has been managed.”

HDFC was swift in its rebuttal. HDFC Vice-Chairman and CEO Keki Mistry said: “This is nothing new, as the person concerned has been writing the same thing over the past two years. All I can say is this is not justified and all our investors are aware of our accounting practices.”

He further said: “We follow Indian GAAP (Generally Accepted Accounting Principles), where the results are shown on a stand-alone basis and it does not take into account the shares of profit from the subsidiaries in the P&L account. These accounting norms treat investments in subsidiaries as cost and only the dividends received from subsidiaries and associates are included as part of the income and its true share of profit in its subsidiaries and associates is not considered part of HDFC’s profits. Since it doesn’t recognise it, we have borrowed through zero-coupon debentures to finance our investments in subsidiaries and, therefore, the interest cost on such borrowings amounting to Rs 485 crore during FY12 (net of tax) has been charged to Securities Premium account according to Section 78 of the Companies Act.”

Considering this, Mistry added, as and when IFRS was made applicable under Indian GAAP, the overall profits would further rise as some expenses on borrowings and loan sourcing would require to be amortised instead of currently being fully charged to the profit and loss account in the year of payment.

In a statement, HDFC said its management completely disagreed with the report as the analyst concerned had not tried to meet anyone from HDFC before making the report to verify facts. Moreover, it was surprising Macquarie in its report as recently as May 7 this year had put a price target of Rs 775 on HDFC’s stock with an outperform rating based on same facts and figures. “We are, therefore, unable to understand what prompted the analyst to change his recommendation and outlook within a month’s time,” HDFC said.

Questioning the disclosure practice at HDFC, the Macquarie report had said: “It’s surprising to us that HDFC doesn’t disclose any of its corporate sanctions and disbursements which LIC Housing Finance does every quarter. Additionally, LIC Housing also discloses interest income on corporate advances – something that HDFC doesn’t do and that makes it tough for investors and analysts to compute the actual spreads earned in their corporate business.”

According to Bloomberg, out of nearly 50 analysts, 31 have ‘buy’ rating, 16 have ‘hold’, while only two have ‘sell’ rating on the HDFC stock.

Vaibhav Agarwal, banking analyst at Angel Broking, says: “We have a ‘neutral’ rating on HDFC due to higher valuations. We believe there are no catalysts for its growth.”

Adarsh Parasrampuria, analyst at Prabhudas Lilladher, said: “These things on provisioning and zero-coupon debt are known. HDFC is not over-projecting profits according to me, but only consolidating the same with expenses. We do not see profits going down for the company. We do not expect any de-rating in the stock going forward.”