Housing Development Finance Corporation [HDFC] – Research report

Housing Development Finance Corporation [HDFC]

Recommendation: Strong BUY| Date: 13-Nov-2011| CMP:668| 30 month target: 1000

[Update on Jan 16, 2014: CMP: 1198]

Disclosure:  I am long HDFC since May 2011 at a starting price of 663. I personally hold 9% of my entire portfolio in HDFC. I don’t intend to open/close positions in HDFC over the next 20 business days.

This is a completely independent research. No compensation has been received from any entity in preparing this report.  All data in this report is based on data available from HDFC Financial Statements in their website and from BSE/NSE websites. Sources where appropriate are cited.

This research report is unique for the following 2 reasons:

1) Most recommendations you see provide a short term price target – sometimes 1 month target or even 1 week targets. My recommendations also involve price and time targets but over a longer duration. Rationale: Obviously I don’t know where the markets will be in the next “any period” and invariably all the stocks almost follow the market fluctuations over any long duration. However over a longer duration the likelihood of the fundamentals and the performance of a company being recognized by market forces are much higher which will reflect in the share price.

2) If I ever change my recommendation due to a future performance of the company or relevant regulatory changes I will provide an update. Also readers can feel free to discuss up this stock directly with me if the stock hits a 10% price band (up or down) from the recommended price.

Housing Development Finance Corporation [HDFC] is a financial conglomerate with its presence in the entire gamut of financial services including banking, insurance (life and non-life), asset management, real estate venture capital and more recently education loans. Housing Loans however account for about 52% of the revenue for HDFC.

For the recent quarter ended September 30, 2011, HDFC reported a profit before tax (PBT) of Rs. 1,337.70 crore – an increase of 18% vis-a-vis the corresponding quarter of the previous year. The corresponding Profit after tax (PAT) is Rs. 970.70 crores, an increase of 20%. For H1 2011 the loan approvals and disbursements grew at about 19%.

 Two remarkable areas of performance:

 1) Growing in tough times: The home loans rates have been raised every other quarter over the last 12-18 months. However HDFC has been able to maintain its growth at a healthy rate of 20% without any major compromise in its asset quality. The funding costs have been higher however the margins @ 4.3% and spreads @ 2.3% have remained relatively stable year-on-year.

 2)NPAs: In spite of the increase in the home loan rates over the last several quarters the total Non Performing Assets (NPAs) amount to 0.82% of the loan portfolio-an improvement from 0.86% the figure as on last year [Compare this with public sector banks where the average NPA hovers around 2.3%] . HDFC has been aggressively reducing its NPAs now for 27 quarters in a row. This shows that HDFC has been exercising the due diligence in ensuring the provisioning for NPAs do not impact its performance. Since HDFC primarily deals with collateralized lending, with the home being the collateral, the exposure is also limited.

 The dampeners:

 1)      Loan approvals moderated to 13.3% y-o-y from 28% y-o-y as compared with the previous year

2)      Inflation has been quickly eroding the purchasing power especially over the last 18 months. Oil prices are on the rise and this will impact almost every sector in the country where goods have to be transported. If the major consumption items account for a significant amount of the take home pie the appetite to service a new home loan will reduce. Thus it is very much possible that the plans for purchasing a house may be postponed. While the RBI has signaled that there may not be another rate hike it continues to monitor inflation. If inflation is unabated interest rates can further rise causing prices to spiral upward.

3)      Property prices have remained relatively stable or have been trending up across most of the country. Realty firms have been holding onto a number of finished units in the metros for several months now without reducing the rates. Several small players may be unable to do so for a very long time with the current spiraling financing costs. This can in turn lead to a minor correction in property prices in some regions. Even if this happens in a few pockets, if people get into servicing a loan worth more than their property the inclination to service the loan could fall. This could lead to increase in NPAs. While the reasoning appears farfetched the increasing costs of borrowing could lead us here.

 Outlook:

 We can expect that the revenues of HDFC will increase by about 21% CAGR until Mar 2015. HDFC should be able to maintain margins due to its ability to raise debt cheaper than most of it peers owing to its strong credit. The earning CAGR during this period can be about 19.4% (see exhibit below). The current leading PE based on projected net income for year ending Mar 2012 is 23.6 (CMP/projected EPS = 668/28.4= 23.6). The net income projection for the period Apr 2014 thru Mar 2015, considering further dilution in equity at 1 crore per year, is 47.6.  At this growth rate the markets should be willing to pay a PE of 21 which translates to per share price of Rs. 1000 over the next 30 months, a compounded annual growth of 17.6% over this duration.

 Though there may be short term fluctuations in the market and in this stock due to the Euro zone crisis as this report is being prepared the company has sound fundamentals and shown strong performance in dampening conditions over the past 12 months which could lead to a price discovery in the next 18-30 months. Investors with a long term view can get into the stock at the current levels as the price level appears attractive.