Our Call. HDFC: BUY

The housing finance space has remained unaffected by the economic slowdown, growing steadily at 18-20 per cent over the last two years.

Within this segment, market leader HDFC continues to be on a strong footing, expanding its retail loan portfolio by at least 5 percentage points over the growth recorded by other banks over the last four to five years.

The performance of HDFC is likely to get a further boost, thanks to the Budget proposals for the real estate sector. Key proposals such as increasing the interest deduction limit on home loans and opening up funding avenues for developers will boost buyer sentiment.

At the current price of ₹1,055, the stock is trading at 4.6 times its FY16 book value, which is twice that of peer LIC Housing Finance.

The stock has always traded at a huge premium to its peers in the space, thanks to its steady earnings, good asset quality and leadership position.

Strong loan growth, stable margins on the back of a flexible funding mix and steady asset quality will continue to drive earnings growth of 18-20 per cent for HDFC over the next two years.

The increasing share of subsidiaries, including life insurance, general insurance and asset management, in consolidated earnings is a key driver for the stock. Unlocking the value of these businesses will add value to the core business. Investors with a two-three years horizon can buy the stock.

The residential space continues to maintain steady growth on the back of strong demand from the mid-income group as well as favourable demographics.

HDFC’s retail loans have grown 20 per cent annually in the last five years. Its average loan size is about ₹22 lakh. At 65 per cent loan to value, the average value of the home that is financed is about ₹35 lakh. This ideally comprises of customers who are middle-income salaried employees and first-home buyers. The demand in this segment continues to remain strong while defaults are very low.

The residential space is likely to get another boost with the recent budget proposals.

Key among these is the higher deduction amount for home-loan interest payments. This proposal has increased the likelihood that an individual will buy a home, as one can take on a higher loan for the same cash outgo.

For HDFC, this means a possible increase in its average loan size, which has been hovering in the 6-7 per cent range over the last three to four years.

Aside from spurring buyer demand, some of the proposals, which provide easier funding to developers, particularly in the affordable-housing segment, are likely to increase activity in the developer market. This, along with an improvement in economic activity, should help revive the segment’s growth.

In the June quarter, the company’s loan growth was driven by the retail segment, which grew 17 per cent (net of loans sold). Growth in the non-retail segment remained subdued at 11 per cent. A gradual pick-up in the high-margin, non-retail segment will also aid profitability.

HDFC has also maintained good asset quality. Since inception, the company’s cumulative loan losses have been 0.04 per cent of cumulative disbursements. Its gross non-performing assets in the June quarter stood at 0.7 per cent of loans — 0.55 per cent in the retail segment and 1 per cent in the non-retail segment.

HDFC’s subsidiaries now contribute about one-third of its consolidated profits, significantly more than the 13 per cent in 2010. With a possible increase in FDI in the insurance sector from 26 per cent to 49 per cent, insurance players are likely to get a boost. Any unlocking of value from HDFC’s insurance subsidiaries in future will be a huge trigger for the stock.

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