Two years ago, every market move saw active participation from HDFC Bank and HDFC Limited. The two together accounted for over 20 per cent weight in the Sensex. Collectively they were meatier than Reliance Industries or TCS. Today, the collective weightage of both stocks (16.77 per cent) is about 400 basis points higher than RIL’s.

So, what has changed?

To begin with, it’s the relentless selling by foreign portfolio investors (FPIs), dumping nearly $5.4 billion since October 2021. They have been shedding positions in technology and banking stocks and HDFC twins, being the heavyweights in the space, bore the brunt of the selling. Macquarie Capital’s Suresh Ganapathy points out that FPIs have shed their overweight position on HDFC Bank by nearly 200 basis points from March to December 2021. While there is some FPI interest in HDFC Limited, domestic institutional investors haven’t been adding many shares since 2020. Likewise, they remain underweights in insurance and asset management businesses as well.

 After being super bullish on these stocks till 2020, is the FPI action a strong sign of change in narrative for the HDFC group stocks?

Given the group’s pedigree and positioning, they are unlikely to go out of vogue. But after enjoying the ‘high-growth, high-quality’ tag for several years, a reset in investor expectations seems inevitable. They may be more a steady-state return generator hereon.

Here’s what led to the change and how investors should treat the HDFC group stocks, going ahead.

Losing out to competition

The one common thread that connects the underperformance of all listed HDFC group companies – HDFC Limited, HDFC Bank, HDFC Life Insurance and HDFC Asset Management Company (HDFC AMC) – is how they couldn’t fight the competition.

For HDFC Bank, the pressure mounted from the December quarter (Q3) FY21, after the Reserve Bank of India barred it from issuing new cards and launching products under its critical Digital 2.0 initiative. While the ban on both businesses has now been lifted, it needs to be seen if the damage it caused can be undone. Credit cards account for over 10 per cent of the bank’s retail products and are an important source of fee income and profitability. While HDFC Bank remains a leader in the space, the ban allowed its two close competitors – SBI Cards and ICICI Bank – to eat a large part of its pie. SBI Cards and ICICI Bank have seen 200-300 basis points (bps) increase in their market share since December 2020. Recent credit card spends data indicates that HDFC Bank’s market share (in terms of spends), from over 30 per cent prior to the ban, isn’t improving briskly. At 22.8 per cent in January, the tough fight from peers continues. It may not be easy for the bank to capture the lost ground.

Also, at a time when peers such as ICICI Bank, Axis Bank, Kotak Mahindra Bank and even the public sector banks significantly increased their share of retail loans (over 60 per cent of total loans), HDFC Bank, which has historically been referred to as India’s leading retail lender, took a backseat. The bank’s share of retail loans has dipped below 46 per cent of total book. This was due to the planned strategy to expand focus on corporate and small business loans. Implemented in mid-FY20. Consequently, the rejig in growth focus and slowdown in the retail space has impacted overall revenues and loan growth (see table).

HDFC Limited, too, lost its market share in the housing finance space to banks. Among non-banks, HDFC’s rate of interest is a tad higher as it supposedly is the price a customer pays for minimum hassles in loan processing (much of the process digitised and least walk into branches). However, at a time when banks were rushing to lower the rates to sub 6.8 per cent, it was only around September 2021 that HDFC slashed its rate of interest to 6.7 per cent. By that time, the broad trend that was playing out in the housing finance space – that of higher-than-usual prepayment rates and customers migrating to banks for cheaper rates – didn’t spare HDFC Limited.

Consequently, in FY21, loan growth moderated to 10 per cent year-on-year while it stood at 11 per cent year-on-year in Q3 FY22. These numbers are significantly off the past historic growth rates of 14-16 per cent seen till FY19. With the home loan market getting segmentalised into two components – affordable housing (largely comprising smaller NBFCs such as Home First and Aavas Financiers) and mid-market segment (loan value of ₹35 lakh-₹1.5 crore) dominated by banks, HDFC may take a while to regain the right balance. With the average ticket size of the lender sticky at ₹25-₹35 lakh, HDFC hasn’t caught on to low-cost housing yet. Its focus remains on high-end home buyers and upper middle class.

Behind the curve

The story is slightly different with HDFC Life and HDFC AMC, which had record listings in 2017 and 2019 respectively. For long, they were seen as undisputed first choices in their respective spaces, which helped them hold on to their expensive valuations. But things took a turn last year.

In HDFC Life’s case, the higher share of protection plans (at over 12 per cent in FY18) was its USP, placing it ahead of peers. However, the competition today is not behind. With peers having 12-14 per cent share of protection plans and value of new business margin in the ballpark of 22–25 per cent for the listed players (up by 400-500 basis points in the last three years), the unique proposition of HDFC Life is reducing gradually.

While for the sector, much of the premium growth is frontloaded by long-term savings plans, for HDFC Life, in specific, the share of these products is relatively higher. In a sense, the construct of listed life insurers is such that the point of differentiation among companies is thinning and this is challenging the premium that investors were willing to ascribe to HDFC Life These fundamental changes, along with its foreign partner, Standard Life, cashing out of the company (holding down 26 per cent since listing), have led to the stock’s underperformance.

For HDFC AMC, its slow adaptation to the market dynamics is costing the company its valuation premium. At 33.8 FY22 estimated earnings, its premium to Nippon Life (closest competitor at 27.4x) is shrinking. In 2019, HDFC AMC traded at over 50 per cent premium to Nippon. HDFC AMC’s gradual loss of market share even in the equities segment and the company not keeping pace with the market preferences are the key reasons for underperformance.

It’s the season of passive investments and Nippon, with a higher share of ETF (exchange traded funds) products, is racing ahead in the game. Even AMCs such as Axis, UTI and IDFC have been quite aggressive with new fund offers and ETFs, thus making a fast recouping of market share tough for HDFC AMC. For instance, among the 300-plus passive schemes, HDFC AMC has only 14 schemes with assets under management at less than ₹20,000 crore (4 per cent market share). Large peers such as ICICI Prudential AMC and Nippon AMC have more schemes and, importantly, a larger AUM base of ₹50,000-55,000 crore. Therefore, just as with HDFC Bank, the AMC business too may find it tough to regain its position in the market

Meanwhile, for HDFC Bank and HDFC Limited, asset quality issues cropping up from retail loans and builder book may delay a full-fledged recovery in sentiments.

New normal

The natural expectation from a market leader is that it will continue outperforming peers. After all, HDFC Bank proved critics wrong when it doubled its loan book to ₹6.5 lakh crore in just four years by FY18. Same with HDFC Life and HDFC AMC. Their strong banking channel partner parentage and high growth helped them garner stellar valuations and listing gains.

But today the group as a whole, and its lending businesses specially, has reached a stage where size is no more the critical advantage. If any, the current bulk of balance sheet for HDFC Bank and HDFC Limited does not position them favourably to repeat the past growth rates. Under the current circumstances, lenders will have to prioritise between growth and asset quality as ensuring high growth and clean book may be a difficult proposition.  In other words, the group is well off its past growth rates. First signs of the slowing became visible in FY20. FY21 highlighted the point further. What’s more, going by the Street’s consensus earnings estimates for FY22-FY24, the group may be in no hurry to reclaim its historical performances. This holds true with other listed companies of the group too. In other words, it is unlikely that any of the group companies can undo the damage done in the near term. Slower than past growth could be here to stay.

But will HDFC group stocks lose their sheen? May not. What could change is the way the investors would approach these stocks. They will no longer be favoured as high growth options. Instead, they could take the badge of ‘steady state’ stocks. In other words, they are poised for a change from ‘wealth generators’ to ‘value-picks’. There may not be much volatility in earnings or quality of assets. Loan growth may moderate and be maintained at a consistent rate, probably in the mid-teens range for the lenders, 14-17 per cent (premium growth) for HDFC Life and 8-10 per cent (revenue growth) for AMC business.

Accordingly, their valuations too will moderate. From over 4x one year forward price-to-book, HDFC Bank’s asking rate has fallen by 15 per cent in a year. Given that RBI action has raised doubts over the bank’s technological practices, the scepticism is unlikely to fade soon and the bank’s asking price may remain below its historic levels for a while. As for HDFC Limited, the core lending business was de-rated to 1x price-to-book in 2020. Since then, it’s been challenging to improve its valuations as against the past numbers (FY14 – FY19) of 1.2 – 1.4x one-year forward price to book. Expect HDFC Limited to be more pronouncedly treated as a holding company (as against a housing financier), going forward. That. on a consolidated basis, the stock trades at 2.5x FY22 estimated book (more than twice its standalone valuations) indicates that a larger part of its asking rate draws strength from its subsidiaries. This trend is expected to continue and a paucity of well-managed financial conglomerates in India will keep demand for HDFC stock buoyant. Therefore, a comprehensive re-rating would depend on the performance of all subsidiaries.

HDFC Life and HDFC AMC trade at a premium to others in their sector, partly for their parentage. Having said that, investors believe that should the life insurance space witness a convincing revival in demand led by protection plans, HDFC Life may be a better play compared to competition.; same with HDFC AMC as well. If the tide once again turns favourable for active funds, HDFC AMC would stack on top in investors’ shopping cart.   But there is little visibility on how soon the tide turns in favour of these companies. Therefore, HDFC AMC’s valuations may plateau at current levels or correct further if its financials remain a laggard compared to peers.

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