Neha Dave Moneycontrol Research
Highlights
-Robust loan growth; size not a deterrent -Stable margins aided by superior funding profile -Pristine asset quality -Improving subsidiaries performance -Compelling valuations; investors should not ignore this financial powerhouse
HDFC, the largest housing finance company (HFC), reported earnings ahead of consensus estimates aided by better-than-expected margins, controlled operating expenses and lower tax rate. The broad Q3 numbers are consistent as ever. Loan growth remains strong, margins are stable and asset quality is pristine.
Net profit grew to Rs 2,114 crore in Q3 FY19 as compared to Rs 5,300 crore in Q2FY18. However, adjusting for exceptional items and one-time transactions (i.e. profit on the sale of subsidiaries and consequent special additional provisions), the operating profit before provisions would have been Rs 2,984 crore for Q3 FY19 compared to Rs 2,352 crore in the same period last year, representing a growth of 27 percent.
HDFC has delivered consistent and superior profitability performance in the last 20 years or so. For instance, HDFC’s return on equity (RoE) was greater than 15 percent for every single year from 1998 to 2018, except for 2009 where it missed by a fraction due to fund-raising in 2008.
While the performance has been good so far, the moot question is: Can it continue in future? Definitely yes. We believe there’s more to follow from HDFC. While the core mortgage business is on a stable growth trajectory, the financial conglomerate stands to gain from the equally strong performance of its subsidiaries.
HDFC remains the key beneficiary of liquidity shift towards strong and top quality names while most HFCs on the street stand 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.
Key positives
Loan growth and margin are the key factors to be watched for in HDFC and it didn’t disappoint on either.
Total lending book of HDFC stood at Rs 385,520 crore as of December-end, up 13 percent YoY. While this number seems slightly lower, it is important to note that growth in the total loan book after adding back loans sold in preceding 12 months was 19 percent YoY and comes on a very high base.
Individual loan book grew 14 percent YoY (24 percent after adding loans sold) and now constitutes 70 percent of the total book. This means despite its high base, HDFC is growing its retail mortgage book much faster than the industry.
Non–individual book growth was muted at 9 percent as the company scaled back on the corporate lending business. Given the turbulent time, this shouldn’t bother investors much.
Spreads in the overall book remained almost stable at 2.26 percent (individual book: 1.89 percent and non-individual book: 3.08 percent). This demonstrates its ability to maintain margins irrespective of a weak environment.
Thanks to its strong brand name and diversified resource profile, HDFC’s cost of funds is very competitive which has helped it maintain spreads in a narrow range of 2.2-2.35 across interest rate cycles.
Key negatives
The gross non-performing loans (GNPA) increased to 1.22 percent, up 9 bps sequentially on the back of an increase in corporate NPAs to 2.46 percent in the current quarter as compared to 2.18 percent as of September- end. The asset quality continues to be pristine on the individual loan portfolio with GNPA at 0.68 percent in Q3.
The lender reported provision coverage of 40 percent for stage three assets disclosed under Ind-AS.
Outlook
HDFC’s stock is just 8 percent away from its 52-week high. While HDFC’s headline valuation seems on a higher side, the core lending business is being valued at 1.7 times FY20 estimated book value, a significant discount to its historical average. Though the transition to Ind AS can make quarterly earnings volatile, the core performance of HDFC continues to be strong.
Additionally, investors get exposure to its valuable subsidiaries. Its subsidiaries (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.
Even after reducing the target value of HDFC AMC after SEBI’s cap on mutual fund fees, we see strong upside to the current market price. It is a rarity to find a quality financial services franchise (and not just a housing finance play) at a compelling valuation.
Markets are staring at multiple headwinds in the near-term. Hence, investors should look to build a portfolio consisting of high-quality business with predictable earnings growth and HDFC should be the core holding of any such long term portfolio.
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