On solid ground

Its ability to sustain growth, maintain healthy margins and likely gains from policy changes augur well for HDFC.

A few recent events have led to renewed optimism towards HDFC. Post formation of a stable government at the Centre, there are high hopes that the insurance sector could see an increase in foreign direct investment (now capped at 26 per cent).

HDFC’s presence in the sector through its 74 per cent stake in HDFC Standard Life is seen in positive light due to the potential of value unlocking through listing of the insurance arm.

More importantly, HDFC’s core business, which was under pressure in the December 2008 quarter, is also showing signs of revival and there are expectations of a further improvement going ahead.

The decline in borrowing costs since January 2009 has already led to an improvement in margins for the company. From a long-term perspective, that HDFC has sustained profitable growth despite stiff competition from public and private sector banks for many years now as well as through different economic cycles, only reassures its prowess in the business, which comes on the back of superior lending practices (leading to high quality assets) and lower costs. Thus, as the business cycle looks up, expect HDFC to benefit from higher profitable growth.

Growth fears easing
The poor demand during the December 2008 quarter was evident in the slowdown of sanctions, particularly to developers and other corporate. HDFC’s circumspect attitude in light of tight liquidity conditions as well as lower demand led to a decline of 8 per cent year-on-year decline in total sanctions during the quarter.

But now, things are seen improving. While real estate prices have corrected by 20-30 per cent over the last one year, builders have launched affordable (lower priced) housing projects in recent months. These moves should be able to spur demand going ahead on the back of economic stability.

In fact, if the March 2009 quarter is anything to go by, there are visible signs of improvement. On a year-on-year, HDFC’s sanctions were up 17 per cent and disbursements by around 18 per cent in March 2009 quarter.

In 2009-10, the management expects loan book to grow at 18-20 per cent. Even though it is lower as compared to about 25-28 per cent growth seen during 2006-08, it is higher than 17 per cent in 2008-09 and is considered healthy. Nonetheless, analysts say that the sector is not fully out of the woods and the road to recovery may be a while away. Thus, they are projecting HDFC’s loan book to grow at around 15-18 per cent in 2009-10 and 2010-11.

Spreads stable
The prevailing tight liquidity conditions during most part of 2008 had put spreads under pressure. An increase in borrowing costs had resulted into spreads (difference between lending rate and borrowing rate) falling quarter after quarter during 2008, touching a bottom of around 2.17 per cent in December 2008 quarter.

However, the improving liquidity in the banking system has led to a substantial decline in wholesale funding costs in the March 2009 quarter. Indicatively, commercial paper rates have slipped from 7.75-14 per cent for the fortnight ended January 15, 2009 to 3.3-10.25 per cent as of April 30. This cool-off in the wholesale funding has helped spreads, even as the company passes most of the gains on this count to its customers.

Consequently, spreads have improved seven basis points to 2.24 per cent in the March 2009 quarter, as the company relied more on its usual source of funds (wholesale segment). Besides a dip in wholesale funding costs, the re-pricing of high-cost borrowings of last year would entail an upward bias to spreads.

What provides confidence is the fact that HDFC has consistently (for more than 24 quarters) maintained spreads between 2.15-2.35 per cent, reflecting its ability to revise lending rates as per market conditions.

This assumes importance in light of the increasing competition from public sector banks like SBI. Demonstrating confidence, Keki Mistry, vice-chairman and managing director, HDFC, says margins are going to stay in the 2.15-2.20 per cent band.

Asset quality healthy
HDFC grew its loan book by 25-28 per cent in the last three years prior to 2006-07. This is in sharp contrast to many peers, which grew their mortgage portfolio by over 40 per cent during this period. A lower asset growth is consequent to the management’s focus on asset quality rather than market share (volumes).

Additionally, the company has been conservative in giving loans, given that its average ratio of loan amount to property value is about 65-68 per cent. These policies have helped HDFC to maintain asset quality even in a difficult environment.

In fact, its non-performing loans (overdue for 180 days) have consistently fallen, halving to 0.6 per cent in the last four years. However, some concerns over its exposure of around 10-12 per cent of total loans to real estate developers persists, and may put pressure on the asset quality if things do not improve going ahead.

Outlook
The company has delivered an average profit growth of around 18 per cent (excluding exceptional items) in the last five years. The comfort from lower operating costs, stable margins and high asset quality would help sustain profit growth of around 16-17 per cent annually in the next two years.
 

STABLE GROWTH
in Rs crore	FY09	FY10E	FY11E
Net interest income	3,053.00	3,615.00	4,259.00
Operating profit	3,269.00	3,812.00	4,445.00
Net profit	2,283.00	2,652.00	3,071.00
P/E (x)	27.20	23.40	20.20
P/BV (x)	4.70	4.20	3.70
Loan book growth (%)	16.70	15.00	18.00
E: Analyst estimates

In the long run, growing urbanisation, rising disposable incomes and favourable demographics, will ensure that demand for housing (and thus, housing finance) would continue to remain robust.

HDFC also has presence in the financial services space through its subsidiaries and associates, like HDFC Bank , HDFC Standard Life . Analysts have put the combined value of these businesses at around Rs 550-650 per share of HDFC, of which about 40 per cent is the life insurance business and about 45 per cent is for banking.

With the prospect of its insurance and asset management arms getting listed in 2010, the same should lead to unlocking of value. At Rs 2,186, the stock is up nearly 75 per cent since March 9. At current levels, it is trading at its estimated 2010-11 price to book value and can be considered on dips for 15-20 per cent in the next one year.