HDFC Ltd Strong business model but fairly valued:: Religare Research

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HDFC Ltd
Strong business model but fairly valued


We initiate coverage on HDFC with a HOLD rating and a target price of
Rs 750/sh. HDFC is among the better diversified plays on financial services in
India with a leadership position in the under-penetrated housing finance sector
and exposure to other financial services through its subsidiaries. We are positive
on the mortgage financing segment and believe that HDFC would clock a 20%+
CAGR in loan book and earnings through FY13. While rising interest rates and
competitive pricing could result in spread compression for some players, we note
that HDFC has consistently maintained spreads at 2.2–2.3%. Asset quality is likely
to remain healthy and we expect provision expenses of just ~6bps for the
company. Having said this, we believe current valuations of 18x FY12E earnings
(core business) price in the positives, leading to our HOLD rating on the stock.

Competitive intensity to remain high: We note that competition in the mortgage
financing space has intensified over the last two years, with SBIN and LICHF
turning more aggressive. Nonetheless, we expect HDFC to report a 22% CAGR
in disbursements over FY10-FY13 as underlying demand remains strong and the
company leverages its extensive distribution network, domain expertise and
brand recall.

Loan growth to recover; spreads to stabilise at 2.2%: HDFC’s loan growth was
muted at a 16% CAGR over FY08-FY10 due to the sale of loans to HDFC Bank
(HDFCB). However, we expect loan growth to recover off the low base and record
a 22% CAGR over FY10-FY13. We believe that HDFC would maintain its spreads
at 2.2–2.3% (in line with the historical trend), supported by a dynamic funding mix
and a well-matched asset-liability tenure. However, rising costs of wholesale
funding and continued stiff competition remain the key risks for margins.

Asset quality will remain pristine; costs benign: HDFC’s asset quality has
remained one of the best in the industry supported by a robust credit appraisal
process. We expect asset quality to hold firm and are factoring in loan loss
provisioning of ~6bps. We believe that operating leverage has largely played out
for HDFC and expect the cost/income ratio to be maintained at ~7% levels.

Valuations full; initiate with target of Rs 750/sh: We expect earnings growth for
the core business to remain strong at a 22% CAGR over FY10-FY13 with core
ROE maintained at +30%. Our SOTP-based target price for the stock is
Rs 750/sh, comprising Rs 516 for the core mortgage business (20x FY12E EPS)
and Rs 233 for the company’s subsidiaries and stake in HDFCB (after a 15%
holding company discount). A sharp rise in rates and a slowdown in mortgages
are key downside risks, in our view.