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HDFC: Pricing power compensates rise in funding costs
Consistent performance continues but largely priced in
We maintain our Hold rating on HDFC with a TP of Rs670. Mortgages remain one
of the finest assets in India and HDFC’s liquidity management is
uncharacteristically commendable for a non-bank. Of course there are a larger
number of credible players than even two years ago and rates offered by stateowned banks are still low. Margins and growth of life insurance new business may
get hurt by recent regulatory changes. Valuations look relatively demanding and
may have factored in this advantage.
3QFY11 results – Net profit higher than estimate due to treasury gains
Net profit of Rs8.91bn was 9.6% above our estimate and 4.5% above consensus
but the difference largely arose from profit on sale of investments. As has been
the case in previous years also, 3Q sanctions (-21% QoQ) and disbursements (-
23% QoQ) dipped. Individual loan demand continues to be strong with individual
sanctions and disbursements up 39% YoY and 38% YoY for 9MFY11. Outstanding
loans were up 20.6% YoY, net of sell-down of loans - the company sold
Rs21.54bn of loans during quarter, taking the last 12m number to Rs53.87bn.
Emerging positives but may not result in earnings acceleration
HDFC’s 75bps lending rate increase over six months for an intensely competitive
product should have brought to rest concerns of significant margin erosion. It has
successfully utilised its excess reserves to make regulatory provision on teaser
loans. Its competitive positioning in the developer loan market has arguably
improved due to cases of financial wrongdoings with real estate loans of some
competitors coming to light. However, competitive pressures are still out of sync
with funding cost increases, and part of the spread expansion in FY11E could
unwind in FY12E.
SOTP valuation; high property prices a downside, less competition an upside
We value HDFC’s core mortgage business on a 2-stage Gordon growth model.
Life insurance is valued on appraisal value, asset management at a % of AUM and
the stake in HDFC Bank at the latter’s target price. Key downside risk is property
prices staying high and affecting demand. Key upside possibility is reduced
competition from state-owned banks.
Investment thesis
Outlook
We expect HDFC to deliver a 18-20% core mortgage loan disbursements growth CAGR for
the next three years with steady margins arising from the policy of not taking any
mismatches to the extent possible, either on duration or rates. Despite state-owned banks
getting more aggressive in this business, HDFC's long-standing experience, image and the
relatively lower prominence among private banks could help protect market share. Since
HDFC is predominantly focused on cash flow-based lending and runs on conservative loan-tovalue ratios, retail asset quality is likely to remain under control. However, a return to
historically higher loan growth levels seems unlikely unless property prices correct
significantly, and any re-rating will be critically dependent on growth. The life insurance
business on a sector-wide basis could suffer from low growth due to recent regulatory
changes. Being a predominantly wholesale funded entity, the stock tends to be under
pressure in times of rising rates as it currently the case. On account of these factors, we rate
the stock a Hold.
Valuation
We value HDFC's core mortgage using the 2-stage Gordon Growth model. Assumptions for
the 2-stage model: RoE = 30%, cost of equity = 14.7% (using DB quant estimates), initial
period growth = 20%, perpetual growth = 5% (in line with stable nominal GDP growth of
developed economies), initial payout = 40%, perpetual payout = 50%. The life business is
valued on appraisal value (i.e., new business plus embedded value), asset management
business at 5% of AUM, stake in HDFC Bank at the latter's target price, unrealised gains
(excluding HDFC Bank) at market price and the rest on earnings. The resultant rounded-off
target price is INR670.
Risks
Key downside risks are i) property prices staying high and eventually affecting demand for
mortgages - HDFC, unlike banks, is a single-product entity, and ii) intermediation costs rising
as walk-ins reduce and more business is sourced by individual or corporate agents.
Key upside possibilities are i) higher-than-expected growth in home loan disbursements due
to a sharp correction in property prices, and ii) reduced competition from state banks.
Q2FY11 results – higher than estimates
HDFC Ltd reported 3QFY11 net profit at Rs8.91bn, 9.6% higher than our estimate and 4.3%
above Bloomberg Finance LP consensus. While core operating profit was below our
estimates, higher than estimated treasury income pulled up the net profit.
Valuation, earnings and target price
Valuation & Target price
We value HDFC’s lending business on the 2-stage Gordon growth model, suitable for
relatively high-growth companies with high payout ratios. The HDFC Bank stake is valued at
the latter’s target price, insurance on appraisal value, AMC on % of AUM and others P/E or
P/BV depending on the nature of the business.
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