-Loan growth driven by individual loans, corporate loan growth muted
-Stable margins aided by superior funding profile
-Comfortable asset quality and adequate provisioning
-Improving performance of subsidiaries
HDFC’s reported Q2 earnings was ahead of consensus estimates and was aided by one-off gains of Rs 1,627 crore from a stake sale in Gruh Finance and due to lower taxes. Its net profit rose by 61 percent year-on-year (YoY) to Rs 3,962 crore in the second quarter of FY20. Its operational performance was steady and consistent as always.
The housing finance segment is currently plagued with multiple issues including funding constraints, slower growth and stringent regulations. This makes investors ponder – is it worth considering HDFC, the largest housing finance company (HFC) at this juncture? The answer is definitely yes. HDFC has delivered consistent and superior profitability for more than three decades and despite sectoral headwinds, HDFC’s core mortgage business is on a stable growth trajectory.
Further, more can follow from HDFC as the financial conglomerate stands to gain from equally strong performance of its subsidiaries and associate companies, most of which are listed now. But does that merit buying the stock of HDFC especially when its subsidiaries can be bought directly?
Well, the concept that “the whole is greater than the sum of its parts,” often does not hold true in the investment world. This is because when multiple businesses are held together as one single listed entity, they are usually not worth more as market accords a “holding company discount” to a conglomerate.
That said, HDFC being successful capital allocator with the ability to drive value creation should command least possible discount. With market assigning higher discount because of holding company structure and due to subdued sentiments towards mortgage business, HDFC’s core lending business is being valued cheaply and presents a good investment opportunity.
Loan growth, margin and asset quality are the key monitorables and HDFC didn’t disappoint on any.Strong loan growth despite the size
Total lending book of HDFC stood at Rs 426,739 crore as of September-end, up 12 percent YoY. While this number seems slightly lower as compared to the lender’s historical performance, it is important to note that growth in the total loan book after adding back loans sold in preceding 12 months was 18 percent YoY and comes on a very high base.
Growth was led by individual loan book which grew by 15 percent YoY (24 percent after adding loans sold) and now constitutes 72 percent of total loan book. HDFC is growing its retail mortgage book much faster than the industry indicates that huge size isn’t a deterrent for the lender.
Non–individual book growth was muted at 3 percent as the company scaled back on the corporate lending business due to unfavourable lending environment caused by tight liquidity conditions.
The management is increasingly targeting the economically weaker section (EWS) and lower income group (LIG) segments in affordable housing. The latter constituted 36 percent of approvals (incremental sanctions) in volume terms and 18 percent in value terms during the first half of FY 20. Average loan size for the EWS and LIG segments stood at Rs 10.1 lakh and Rs 17.5 lakh, respectively, much smaller when compared to the average loan size of Rs 27 lakh in the individual segment. Lower ticket sizes in affordable segment implies growth is volume driven.
Spreads in the overall book remained almost stable at 2.26 percent (individual book: 1.93 percent and non-individual book: 3.08 percent). Thanks to its strong brand name and diversified resource profile, HDFC’s cost of funds is very competitive which has helped the company maintain spreads in a narrow range of 2.2-2.35 across interest rate cycles.
Apart from aiding low cost of funds, HDFC’s resource raising capabilities and funding mix helps in mitigating the inherent tenure mismatch and interest rate risks in the housing finance business. We are encouraged by the fact that HDFC runs a well matched asset liability maturity (ALM) book with lower gaps in medium term buckets as against peer HFCs.Comfortable asset quality, excess provisions provide cushion
The overall gross non-performing loans (GNPA) inched up slightly to 1.33 percent as at end September on the back of rise in corporate NPAs to 2.87 percent which increased by 19 bps sequentially. That said, overall asset quality continues to be comfortable with GNPA on the individual loan portfolio at 0.7 percent in Q2.
The lender reported provision coverage of 43 percent for stage 3 assets disclosed under Ind-AS.
The management’s policy of creating 30 percent provisions from one-off gains has resulted in total provisions at 1.72 percent of exposure at default, which is in excess of the regulatory requirement. As per NHB norms, HDFC is required to carry a provision of Rs 3,559 crore against which it holds provisions of Rs 7,313 crore as at end September.Valuations undemanding
HDFC remains key beneficiary of liquidity shift towards strong and top quality names while most HFCs on the street stands crippled by the tightened liquidity. More importantly, the competitive intensity has moderated following the liquidity crisis, which we believe will help HDFC accelerate market share gain.
There are growing concerns of its funding to real- estate sector. But out of the total wholesale (non-individual) exposure, HDFC’s construction financing book is only around 12 percent of total book while rest is lease rental discounting and corporate exposure which is relatively less vulnerable.
HDFC’s stock is just 8 percent away from its 52- week high price. While HDFC’s headline valuation seems on a higher side, the core lending business is getting valued at 1.4 times FY21 estimated book value, a significant discount to its historical average. Though transition to Ind AS has turned quarterly earnings volatile, the core performance of HDFC continues to be strong.
Additionally, investors get exposure to its valuable subsidiaries. Its subsidiaries and associates (HDFC Bank, HDFC Life and HDFC AMC) have an equally blazing track record. With increasing scale and profitability of subsidiaries, more than 50 percent of the value of the company is now derived from subsidiaries.
The core earnings growth in mid-teens may seem lower in comparison to many smaller HFCs. However, we believe, HDFC’s ability to deliver consistent performance across interest rate and growth cycles in spite of its large size and high competition commands premium valuation to peer group.
It is rare to find a quality financial services franchise (and not just a housing finance play) at a compelling valuation. With mortgage financing space staring at multiple headwinds in the near-term, HDFC offers a good investment opportunity.