Fear of a looming real estate bubble made investors wary of home finance stocks last year. Worries that a 30-35 per cent decline in home prices would erode loan portfolios, weighed on them.

But HDFC, the market leader in the home finance segment, is on a strong footing. The company’s retail loan portfolio has maintained its strong momentum, driven by first-time home buyers in the middle-income group. It also managed to maintain its margins in one of the most challenging quarters (September).

At the current price of Rs 800, the stock is trading at four times its one-year forward book value compared to a long-term average of 4.6 times. We expect earnings growth of 18-20 per cent over the next two years.

Property bubble fears in the Indian market also seem overdone. While there could be some correction in select markets, which saw very high appreciation on the back of investment demand, a countrywide decline is unlikely when residential home buying remains strong.

HDFC’s average loan size is Rs 22 lakh. At just 65 per cent loan-to-value, the average value of the home financed is about Rs 35 lakh. This segment consists of first-time home buyers, who plan to occupy the home; they are not too sensitive to interest rates. The growth of 26 per cent in HDFC’s retail loans in the September quarter reflects this sentiment. The retail segment constitutes 70 per cent of HDFC’s loan book and growth in the first half of 2013-14 has mostly (91 per cent) been from this segment.

HDFC has also managed funding challenges well. The firm managed the 250-basis point spike in short-term interest rates in July quite well. The flexibility to switch between different sources — bank borrowings, deposits and bonds — helped maintain margins.

Margins are expected to improve in the second half of 2013-14 on two counts. With short-term rates falling from the September highs, cost of funds for HDFC may recede. The company has also raised its lending rates twice since August. HDFC’s asset quality is stable. In the September quarter, the gross non-performing assets fell to 0.59 per cent in the retail segment, from 0.61 per cent in the previous quarter.

Subsidiaries add value Besides HDFC Bank and Gruh Finance, HDFC holds stakes in life insurance, general insurance and asset management businesses. The contribution of its subsidiaries in the consolidated earnings has increased in the last three years, rising to a third of consolidated profits from 13 per cent in 2010. The subsidiaries can be valued at Rs 350 a share. Unlocking of value in these businesses will add an upside to the stock.

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