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Structural demand drivers buoy long-term outlook
We initiate coverage on the Indian housing finance sector with a fundamentally
positive long-term view considering a robust demand outlook and low mortgage
penetration levels in India. While competitive intensity will likely remain high for
housing finance companies (HFC) as banks continue to focus on the segment, we
expect HFCs under our coverage to report loan book growth of +20% (CAGR)
over FY10-FY13 as demand remains strong. However, competitive pricing and
rising interest rates would put pressure on margins of some players. Asset quality
is expected to remain healthy despite strong growth, as defaults on residential
mortgages are very low.
HFCs have outperformed the Sensex in the last one year and while valuations are
no longer cheap, we believe that stock performance would be supported by
robust earnings growth (23% CAGR over FY10-FY13E for our coverage universe).
While we remain positive on HDFC from a long-term perspective, we believe the
scope for further re-rating is limited, leading to our HOLD rating. We recommend
a BUY on LIC Housing Finance (LICHF) as we expect its strong earnings
momentum to drive stock performance. We also rate Dewan Housing Finance
(DEWH) a BUY given attractive valuations and a robust growth profile.
Demand for housing finance remains strong: While growth in housing demand
could be subdued in FY11 (in terms of residential area sold), we believe home loan
disbursals would remain strong driven by a higher ticket size of loans. We also note
that affordability levels of Indian households have risen compared to FY06,
supported by the strong growth in disposable incomes. We remain bullish on the
housing finance sector in the long term as we see several structural demand drivers,
including a wide demand-supply gap for housing, rising urbanisation, continued
growth in disposable incomes and low mortgage penetration. We are factoring in a
23% CAGR in disbursements over FY10-FY13 for HFCs under our coverage.
Stiff competition from banks: We expect competition to remain fierce as banks
(particularly SBIN) continue to focus on housing finance and ICICI Bank too plans
to scale up operations in the segment. This could lead to the continuation of teaser
(low-interest) loan schemes for a prolonged period, in turn exerting pressure on
spreads. We note that the incremental spreads on residential loans originated by
LICHF are significantly lower than the overall spreads on its loan book.
Rising rates pose some risks to growth and spreads: A rise in interest rates could
lead to cyclical compression in HFC spreads due to the wholesale-funded nature
of their liabilities (particularly if teaser rates continue for an extended period).
However, we note that HFCs have maintained a balanced asset-liability mix and
the proportion of floating assets is higher than floating liabilities. As a result,
HFCs can protect margins by increasing their PLRs.
Valuations: While we believe that HDFC is one of the best diversified plays in
the Indian financial services space, we foresee limited upside from current
valuations of 18x FY12E EPS (after adjusting for subsidiaries), leading to our
HOLD rating. We are bullish on LICHF despite the sharp
re-rating over the last 18 months as we believe that earnings growth (27% CAGR
over FY10-FY13E) would lead to a robust performance. The stock is currently
trading at 2.5x FY12E BV and 11x FY12E EPS. We are also positive on DEWH as
we expect the company to report strong business growth with stable margins, by
virtue of its niche presence and smaller size. At current valuations of 1.8x FY12E
BV and 10x FY12E EPS, DEWH is trading at a significant discount to peers.
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