Subsidiaries now matter more for HDFC

Core business, performance of subsidiaries and capital deployment will be closely monitored in 2018

That a large section of the realty sector, barring affordable housing, is witnessing a slump is a known thing. Therefore, the pace of mortgage business growth settling at 14-18 per cent in the past few quarters has not been much of concern for HDFC Ltd.

While its positioning as India’s largest financier conglomerate has proved helpful, the growing relevance of its subsidiaries has helped tide over the slowdown in the real estate sector. In fact, if the subsidiaries continue to grow at a faster pace, their sum-of-the-part (SOTP) value in HDFC could grow over time. 
 

If the subsidiaries accounted for 50 per cent of HDFC’s sum of the parts or its total stock valuations at the start of 2017, their weight is up at 52 per cent at the end of the year. 

This is the first time that analysts peg the combined value of subsidiaries higher than HDFC’s core business. HDFC’s general insurance and asset management businesses, whose valuations were benign until recently, saw the maximum appreciation, while a large support was lent by its banking arm as shares of HDFC Bank rose over 55 per cent in 2017. Justifying the jump in the valuations of subsidiaries, analysts at Nomura say each of the subsidiaries are best in class in the respective segments and they expect them to grow at 20 per cent from FY17–FY20. Growth in SOTP valuations of its core mortgage business though has been slower compared to most subsidiaries.

 

The recently announced fundraising plan of Rs 130 billion by HDFC also points to how the financial giant is keen on fortifying its subsidiaries. If Rs 85 billion would be ploughed into its cash cow — HDFC Bank to maintain the parent’s stake at 21 per cent, the general insurance business, too, would benefit from capital infusion. Listing of its asset management arm is likely in 2018, while the remaining capital may be available for its core mortgages business, which may be used to shore it up inorganically. 

Its exposure to the fast-growing low-cost (affordable) housing segment is also a positive, where it has a subsidiary Gruh Finance. But, while the core business generates enough cash flows to comfortably sustain its current growth, some more ammunition is required if HDFC has to regain its past growth rates of 25-30 per cent. On this front, while competitors are reporting high growth in the affordable housing space (sub-Rs 2 million loan segment which qualifies for interest subvention), HDFC’s average ticket size still remains at about Rs 2.5 million. So, accelerated growth in this segment should help.

Another area that analysts point to is the growing share of builder book or non-retail loans. The share of this business to the overall portfolio has inched up lately. While these loans tend to earn better profit margins, the risk they entail is also usually high. Gross non-performing assets (NPA) ratio for this segment has risen from about a per cent last year to 2.2 per cent in Q2FY18 for HDFC. Overall, the gross NPA ratio was maintained at 1.1 per cent in Q2, as those of individual loans segment improved. Any increase in cost of funds could add pressure to HDFC’s profitability in near term.

On the whole, while there are some minor issues for the core business, the subsidiaries should manage to maintain momentum for the HDFC stock, which has appreciated by over 40 per cent last year. How much they succeed in repeating the past performance will be closely watched by investors.