HDFC Ltd - Housing Finance re-defined - Reliance Securities

- Underpenetrated mortgage market with steady loan growth: With 2nd largest population in the world and increasing urbanization, India remains one of the most underpenetrated mortgage markets, and hence, demand for low cost housing especially in Tier 2 and Tier 3 cities should remain high. HDFC Ltd (HDFC) has been able to maintain its market share of ~17.5% in outstanding loans and ~35% in loan disbursements as on FY2012.

- Strong distribution network with efficient cost management: HDFC has national reach with over 311 outlets (incl. 74 outlets of wholly owned distribution company) spanning across 90 locations all over India, which helps in generating maximum (47%) loan revenues for the corporation. HDFC's cost-to-income ratio of 7.3% is the best in its class, as compared to other HFCs (Housing Finance Companies) and banks. Its low cost-to-asset of 30bp has been challenging benchmark for its peers to replicate so far. We believe that the lower cost-to-income ratio is sustainable, given its in-house (89%) sourcing model.

- Dynamic borrowing mix with stable interest spreads: HDFC maneuvers its borrowings mix to adjust for sustainable margins as witnessed across interest rate cycles. Even though there was margin pressure on most of the bulk borrowers, interest spreads for the company were stable at 2.3% in FY2012 despite sharp rise in wholesale rates, supported by a dynamic funding mix and well matched assetliability tenure.

- Excellent asset quality: Delinquencies in mortgages for HDFC have not been significantly high, owing to proper due diligence and stringent credit checks. Since inception, the company has disbursed housing loans aggregating >Rs3.5 lakh crore, while it has suffered loan losses of Rs138cr (i.e. cumulatively less than 4bp in the last 35 years).

- Conglomerate powerhouse: HDFC has three major subsidiaries i.e. HDFC Bank, HDFC Standard Life and HDFC Asset Management. Subsidiaries comprise 1/3rd of the overall company's valuations.

Outlook and Valuation

HDFC should sustain an annual loan growth of ~18% over FY2012-14E, supported by industry growth of 16% considering the underpenetrated mortgage market. Loans to developers are just 13% of total loans, with collateral 3x the value of the loans. Given the experienced management, strong brand value, high return ratios & value driven subsidiaries, HDFC is an attractive investment proposition. At CMP of Rs679, the stock is trading at 2.5x FY2014E ABV. We initiate coverage on HDFC Ltd with an Accumulate recommendation, valuing the standalone entity at 3x FY2014E ABV, and the subsidiaries on a SOTP methodology, thereby, arriving at a target price of Rs771, implying an upside of ~14%.

Risks to the view

- Irrational competition from banks would affect loan growth of HDFC
- Regulatory changes with higher capital requirements could lower ROE
- Nair committee guidelines on priority sector lending eligibility
- Severe economic slowdown would lead to lower growth estimates.

Source : Equity Bulls

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