A safe haven

Strong demand for housing loans and stable real estate prices augur well for housing finance companies. Though the stocks are not cheap, they make good long-term investments.

After last week's 25 basis point cut in the interest rate, the US Federal Reserve has slashed rates by 100 basis points in the past three months.

This rate cuts signify a benign interest rate environment worldwide once again as the US grapples to perk up its drooping economy and prevent the worsening credit crisis. India will also follow the trend of lowering interest rates over the next few months, say industry players.

Moreover, there is a belief that real estate prices, which have doubled over the past three years, seem to be stabilising now. Says Anuj Puri, chairman, Jones Lang Lasalle, "We expect prices to hold at current levels."

Given the combination of falling interest rate and stable prices, demand for housing loans will go up. While banks are slowing down their retail loan exposure which mainly comprise home loans, housing finance companies should benefit more.

Moreover, they are optimistic about maintaining or improving the key fundamental indicators such as net interest margins (NIMs) and non-performing assets (NPAs) due to improving incomes and strong recovery mechanisms.

The market seems to have recognised a lot of these factors over the past one to two months. Most housing finance companies have zipped past the Sensex and even the top two banks in housing loans namely ICICI Bank and SBI. Market experts believe that fresh investments should be considered on declines or at the current levels with a one year investment horizon.

Housing gains
In order to control inflation, the RBI has raised interest rates and adopted restrictive measures on bank advances. Bank credit, which grew at 30 per cent a year over the past three years, has slowed down to 25 per cent this year so far.

Besides, RBI has also increased provisioning for bank loans to retail and real estate sector. As a result, housing finance companies, which are more focused and understand the customer better than banks, such as HDFC, LIC Housing Finance and Dewan Housing Finance have seen their loan books and profitability improve in the first half of FY08.

For example, LIC Housing Finance's loan book jumped 36 per cent and 25 per cent in Q2 FY08 and H1 FY08 respectively compared with 21.5 per cent CAGR in FY04-FY07.

Similarly, its net profit grew at 54 per cent in trailing four quarters ending Q2 FY08 compared with 18.5 per cent over FY04-FY07. Moreover, net interest margin "� a key indicator "� witnessed an expansion of 50 basis points.

Demand to remain strong
Industry players are confident of achieving a loan growth of atleast 25 per cent in the medium term, which is more than what can be expected of total credit growth. The demand is likely to come more from tier-2 and tier-3 cities. This is because there is huge demand-supply mismatch in housing.

According to the Tenth Five Year Plan, there is shortage of 22 million homes. On the other hand, even disposable incomes and affordability of people are rising as salaries go up. However, possible interest rate cuts and stable property prices are expected to have a greater impact.

After a 400 basis point increase since the last few years, interest rates have remained stable. Industry experts believe that interest rates in India will follow the US Federal Reserve of downward bias in interest rates.

Says Kapil Wadhawan, vice-chairman and managing director, Dewan Housing Finance, "The liquidity situation has eased a bit and the Fed rate cut will lead to a softening in interest rates in the next six months."

In the home demand equation, property prices play a more important role than interest rates. S K Mitter, director and chief executive officer, LIC Housing Finance says interest rates were never a major deterrent considering the tax incentives and overall increase in income levels of the borrower.

Thus, according to him soft interest rates will not be a great trigger. Mitter adds: "Stability in property prices could trigger a higher demand from the user segment due to an increase in affordability." And this seems to be happening. Both DHFL's Wadhawan and Jones Lang Lasalle' Puri do not expect real estate prices to deviate much from current levels. 
 

HEADROOM FOR GROWTH
Company name	Asset size  FY07	Loan book#		Net interest income #		Net profit#		NIMs (%)		Net NPAs (%)
		FY08E	FY09E	FY08E	FY09E	FY08E	FY09E	FY08E	FY09E	FY08E	FY09E
HDFC	69,922*	25.50	25.33	49.07	26.06	48.54	3.30	2.90	2.90	Nil	Nil
Dewan Housing	3,828*	39.34	33.28	43.37	47.06	46.55	74.82	2.90	3.20	1.10	1.00
LIC Housing	17,876	21.74	20.62	35.49	21.66	21.78	21.12	2.70	2.70	1.10	0.60
GIC Housing	2,036	21.94	22.93	6.25	40.00	5.80	46.12	3.80	4.30	2.40	2.00
* consolidated, # year-on-year change (%), Source: Analysts' Estimates

Buy on declines
Both HDFC and LIC Housing have seen a lot of buying interest from the mutual funds in the past two months. The gap between the market capitalisation (cap) of the top three housing finance companies (comparison of LIC and Dewan with industry leader HDFC) has narrowed.

A year ago HDFC's market cap was 28 times and 100 times that of LIC Housing's and Dewan Housing's, which has narrowed to 27.3 times and 78.3 times for Dewan at present. Moreover, valuations of these companies do not look cheap for FY08 and FY09 estimated price to book value even when compared with the top two banks-ICICI Bank and SBI, which are also large home loan lenders.

Thus, buying housing finance stocks makes sense for investors having more than a one-year investment horizon as it is unlikely that prices will correct much.

HDFC (Rs 3058)
Market leader HDFC trades at about 8 times and 7 times estimated price to book value for FY08 and FY09 respectively, which includes the value of its subsidiaries. But even after excluding its subsidiaries (asset management, insurance and banking), the book value is still high at 6.2 times and 4.8 times estimated FY08 and FY09 estimated book value.

Its high valuation is because of its consistent financial performance over the last several years and robust asset quality with non-existent non-performing loans.

The housing finance major's loan book and net profit have grown at a CAGR of 26 per cent and 22 per cent respectively in the last three years. Investors could buy the stock on declines given its consistent performance, market leadership and investments in banking, mutual funds, life insurance and general insurance subsidiaries.

LIC Housing Finance (Rs 376.60)
The second largest housing finance company has improved its financial performance in the recent past. For the first time in the past 15 quarters, it crossed a net interest margin (NIM) of 3 per cent in the September 2007 quarter.

This robust performance is expected to continue as the company expects a disbursement growth of 25 per cent and net NPAs below 1 per cent by FY08.

The company is raising Rs 500 crore by way of a preferential issue of shares, which will further improve its capital adequacy and help in accelerating growth. Its stake in LIC Mutual Fund is valued at Rs 12 per share. The stock trades at a reasonable valuation of 1.8 times and 1.6 times estimated book value for FY08 and FY09 respectively.

Dewan Housing Finance (Rs 180.75)
Dewan Housing Finance trades at 2.6 times and 2.2 times its estimated book value for FY08 and FY09 respectively. This looks on the higher side compared with LIC Housing Finance, which has a larger asset base.

However, the stock has positive triggers like its investments in real estate company -HDIL (Rs 45 per share), Wadhawan Retail (Rs 40 per share) and DHFL Vysya Housing Finance (Rs 11 per share).

Besides, its core business is also expected to do well in the coming years. The management has indicated a loan growth of 35 per cent, NIMs of 3 per cent and net NPAs below 1.25 per cent in this financial year. There is also a possibility of value unlocking in the event of listing of Wadhawan Retail, where it owns 20 per cent.

GIC Housing (Rs 83.35)
Despite having the smallest asset base among housing finance companies, the GIC Housing Finance stock has gained 66 per cent and 85 per cent in the past six months and one year respectively. IL&FS has given a buy rating on the stock last month with a one-year target price of Rs 110, a return of over 30 per cent.

The company's strong focus on tier-2 cities augurs well due to growing demand. Moreover, the company provides a lot of headroom for expansion due to its low gearing of 6 times in FY07, unlike its peers, which have debt-equity ratio of 8-10 times. The GIC Housing stock trades at 1.5 times and 1.2 times its estimated book value for FY08 and FY09 respectively.

The company is a good investment considering cheapest valuation among housing finance companies.