HDFC

HDFC is facing stiff competition from state-run banks.With the P/E at a high, it may be a good idea to exit at the current price point
HOUSING Development Finance Corp, better known as HDFC, is the biggest housing loan provider in India. In fact, its success is so unparalleled that its name has become synonymous with housing loans in the country. It is also one of the most consistent performers in India Inc. For instance, its profit growth remained in the range of 20-25% in six years from FY 2002-2007. As a result, its stock has become darling of investors be it retail, high net worth individuals or foreign institutional investors. However, state owned banks; particularly State Bank of India (SBI) has upped the ante on housing loans, which has intensified the competition.

BUSINESS

India is a country with acute shortage of dwelling units. This shows that housing loans will continue to be a growth business in many years to come. Moreover, housing loan is secured lending. Unlike unsecured lending such as credit cards, the risk of non-performing loans is much lower in mortgage business. The logical conclusion from these facts is that HDFC - being the largest mortgage player - is set to grow in future. But the competitive landscape has dramatically changed. In the good days of boom, it was ICICI Bank, which was the closest competitor of HDFC in terms of housing loans.

Today, public sector banks are coming out with attractive schemes for prospective borrowers. For instance, country's largest bank, SBI, has offered home loans at 8% per annum interest rate to new borrowers. The bank has met with such success that it has become the largest home loan provider in terms of both numbers of homes and volumes.

Other top PSU banks are also offering housing loans at attractive rates. In fact, today PSU banks offer lowest rates for housing loans. No doubt HDFC is feeling the heat. Moreover, PSU Banks have adopted modern practices such as core banking solution (CBS), improved their culture by instilling customer-focused approach at branch level, hired young workforce and introduced incentive based compensation structure. These changes have radically changed the competitive landscape in banking and finance space.

HDFC, however, has an upper hand due to its relationships with many builders across the country and its valueadded services to potential home buyers like qualitative information about builders and projects. Its staff also tends to be aggressive in courting prospective customers, while state-run banks mostly rely on walk-in customers.

FINANCIALS

HDFC’s performance has slipped a few notches in the last few quarters. In fact, in the December ’08 quarter, its net profit fell 2.3% year-on-year. Though profits soared 20.7% in the June’09 quarter, still the performance is lacking on some parameters. For instance, the growth in advances has come down to a mere 8.4% in the June ’09 quarter from 31% a year ago.

It is clear that the company is finding it difficult to maintain the growth rates. Plus, the competition has intensified over last year.

Moreover, the cost of funds for banks is much lesser because 30-40% of their deposits are CASA (current account and savings account) in nature. And because such deposits provide better liquidity than term deposits, banks offer extremely low interest rates. On the contrary, the cost of funds for HDFC is high because it is a non-banking finance company (NBFC) and cannot mobilize CASA deposits. For instance, in FY 2009, the cost of funds for SBI stood at 5.9% compared to 9.7% in case of HDFC. (Refer the chart below for comparison of cost of funds between HDFC and SBI over last five years). With higher cost of funds, HDFC cannot match the interest rates offered by PSU Banks on home loans.

VALUATIONS

The stock is trading at 30 times its trailing twelve months standalone earnings. The adjacent chart shows price to earning multiple (P/E) at various points in last six years. It is clear that only once in last six years that valuations were higher than what is prevailing now. And that happened in last months of year 2007. Those were the days of great Indian bullrun, when the company was growing by leaps and bounds.

The point here is that HDFC is facing strong headwinds in form of stiff competition. However, it seems that stock market has not captured it. On the contrary, the current rally has pushed the stock price bit too far. There is no doubt that HDFC will continue o grow due to its expertise in mortagge business. But, the growth rate may not be as high as invetsors have become used to. Later or sooner, stock market will factor this into valuations. It would be wise for long term investors to sell the stock or at least reduce exposure.