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.

Bank of Baroda

Bank of Baroda is likely to emerge as a much stronger player. Investors can invest in the stock with a long-term perspective

Beta: 1.06
Institutional holding: 38.0%
Current dividend yield: 2.9%
Current P/E: 6.5
Current m-cap: Rs 10,035.6 cr

WITH A network of over 2,800 branches across the country, Bank of Baroda (BoB) is one of the largest public sector banks in India. The bank has been growing rapidly in the last few years, and it closed FY '08 with 46 branches in abroad—a mark that very few banks have achieved. BoB's wide base has helped it to tap all the resources-in rural, semi urban and the metro markets-to grow its balance sheet and revenues. BoB's international advances grew by more than 30% in FY '08, as a result of its wide presence in overseas markets.

BUSINESS

BoB's balance sheet has grown at a compounded average growth rate (CAGR) of 25.9% per annum in '06-'08. And, in terms of the growth trajectory, BoB has joined the fray of the top PSU banks, like, Punjab National Bank (PNB) and Bank of India (BoI).

The turnaround actually started becoming visible in the FY '06, when for the first time in the current decade the balance sheet expanded by close to 20%. Since, FY '06, the bank's loan book has been increasing at a rate in excess of 25%, but the deposits have been growing at a bit slower rate. This has helped it in improving the credit-deposit ratio i.e. a higher portion of deposits is extended as advances.

However, BoB's net interest margin (NIM) has been under pressure as it has come down from 3.4% in FY '05 to 2.9% in FY '08. One may get an impression that this has happened because the bank has not been able to pass on the increase in cost of deposit to its customers. However, this is because the bank had to step up its deposit mobilisation in the last two years in order to maintain high credit growth. This resulted in higher interest payments on account of higher deposits, thereby, compressing the net interest income, which ultimately led to fall in NIM. This shows that there was a trade off between BoB's shrinking NIM and growth in its advances. And, it has paid off, as the bank's profit grew at a CAGR of 30.8% in last three financial years.

The non-interest part of BoB's revenue has not been growing as fast as the fund-based revenue. The bank needs to improve its performance on this parameter. In the six months ending September '08, the bank's profit has grown by 16.5% on a year-on-year basis, propelled by 32.5% growth in its advances. It must be noted that the growth in advances took place in a sluggish business environment.

The NIM was also under pressure in the first half of the current financial period. This is visible as the interest expenses grew by a higher percentage than interest income. However, BoB rationalised its other expenses, and this helped in boosting its profit growth.

The asset quality is very high as the net NPAs formed just 0.43% of net advances at the end of September '08 quarter and on this count the bank's performance is as good as a top private bank. Its capital adequacy ratio stands at 13% and it shows that it is well capitalised.

VALUATION

The stock is trading at a multiple of 6.5 times the trailing twelve months' earnings. The low valuations do not justify the earnings growth, which is much higher. Moreover, the stock is trading at a discount to its book value (Rs 301 per share). A fundamentally sound stock, trading at less than its book value, is often the first to rise when the market starts moving up. Investors are advised to invest in the stock with long-term horizon.