J.P. Morgan - HDFC

HDFC (Housing Development Finance Corporation) (HDFC IN) 4Q FY14: strong retail growth; asset quality improved		Overweight Price: Rs886.45 05 May 2014 Price Target: Rs1,000.00 PT End Date: 31 Mar 2015

HDFC reported in-line PAT of Rs17.2B (up 11% y/y). Although the overall loan growth was moderate, retail loan growth remained robust. Recovery in a large account led to overall improvement in asset quality and the NPL ratio is now 0.69%. Spreads remained resilient across both the retail and wholesale segments. The stock has derated significantly in the face of slowing headline PAT. We stay OW as we believe HDFC has an attractive mix of reasonable valuations (12.8x FY15E P/E, adjusted for subs), sustained high return ratios, and a turnaround of earnings momentum.

Table 1: 4Q FY14 results

P&L (Rs MM)	4Q13	3Q14	4Q14	YoY	QoQ	Comments
NII	20,322	18,383	22,327	10%	21%
Other income	1,008	782	1,469	46%	88%	Strong fee growth due to higher wholesale & advisory fees which tends to be lumpy
Net revenues	21,330	19,165	23,796	12%	24%
Opex	1,132	1,684	1,241	10%	-26%	Lower opex q/q mainly due to seasonality impact
Op. profit	20,198	17,481	22,555	12%	29%
Inv profit	1,049	346	1,276	22%	269%
PBT	20,997	17,577	23,531	12%	34%
Tax	5,445	4,800	6,300	16%	31%
PAT	15,552	12,777	17,231	11%	35%
NIM	4.21%	4.00%	4.10%	-0.11%	0.10%
Spreads	2.30%	2.25%	2.29%	-0.01%	0.04%	Spreads remained resilient, despite higher rates
Gross NPL (%)	0.70%	0.77%	0.69%	0.0%	-0.1%	Recovery in a large account led to improvement in asset quality
Cost-income	5.3%	8.8%	5.2%	-0.1%	-3.6%
ROE	24.6%	18.4%	24.7%	0.0%	6.2%
ROA	3.46%	2.51%	3.29%	-0.18%	0.77%
Balance sheet (Rs B)
Shareholders' Equity	250	290	280	12%	-4%
Borrowings	1,588	1,774	1,843	16%	4%
Term Loans	178	230	330	85%	43%	Higher rates led to substituting bonds with bank loans & retail deposits
Bonds	891	993	948	6%	-5%
Deposits	519	551	566	9%	3%
Loans (on-book)	1,700	1,923	1,971	16%	3%
Retail	1,113	1,309	1,333	20%	2%
Wholesale	587	614	638	9%	4%
Total loans sold	170	162	207	22%	27%
AUM	1,870	2,085	2,178	16%	4%
Retail AUM	1,283	1,471	1,539	20%	5%

Source: Company data, J.P. Morgan calculations and comments.

· Loan growth. Overall AUM growth was moderate at 16% y/y due to low growth in wholesale book, up 9% y/y. However retail AUM growth momentum was strong at 20% y/y. The growth in retail loans is mainly emanating from tier 2/3 cities where the growth momentum continues to remain strong. Management expects retail loan growth of 18-20% in FY15E whereas the wholesale loan growth is likely to remain muted in the medium term given the weak macro.

· Asset quality. Asset quality improved during the quarter with Gross NPLs of 0.69%. A large repayment from a corporate led to improvement in asset quality in the wholesale book (1.01% in 4Q). Retail asset quality remained resilient with NPLs of just 0.53% in 4Q.

· Spreads. Spreads remained resilient and stood at 2.29% in 4Q vs 2.3% last year. Both individual and wholesale spreads were stable compared to the previous year. Higher rates led to substituting bonds with bank loans and retail deposits during the quarter. HDFC’s ability to shift towards different funding mix faster than its peers resulted in stable spreads across different interest rate cycles, in our view.

Figure 1: Retail momentum remained strong

Source: Company data, J.P. Morgan calculations.

Figure 2: Bonds substituted with term loans and retail deposits during the quarter

Source: Company data.

Figure 3: Asset quality improved during the quarter

Source: Company data.

Figure 4: Retail AUM growth was strong whereas wholesale growth remained muted

Source:

 

Investment Thesis

We are OW on the stock, as:

1. We believe HDFC’s flexibility in sourcing different funding segments much faster than its peers has helped it achieve stable spreads across different interest rate cycles.

2. The mortgage opportunity is still very big in India, given that the market is still underpenetrated. We believe the growth opportunity is likely to be strong for HDFC.

3. We believe the current valuations are reasonable in the context of high return ratios and strong growth opportunities.

Valuation

Our Mar-15 PT for HDFC of Rs1,000 is based on a 2-stage Gordon growth model implying 3x Mar15E book and a Rs385/share valuation for the subsidiaries. Our valuation factors in a cost of equity of 15.0%, normalized ROE of ~26%, and terminal growth of 5%.

Risks to Rating and Price Target

1) Significant slowdown in the real estate market could have an impact on loan demand for HDFC. 2) Increasing competition from banks in the home loans space could affect revenue growth in the medium term.

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