Housing Finance Companies (HFC):
While buying a house, a regular homebuyer pays down about 20-40% of the house’s price and borrows the rest. This is where HFCs come into play. They lend to these homebuyers at prevailing market interest rates and make money through interest. HFCs raise the money they lend either from banks, bonds, deposits and many other sources. The cost at which HFCs raise money is lower than the interest at which they lend, thus making the business model viable. The difference between these two interest rates is called the spread.
Spread = [Interest at which the HFC lends to homebuyers] - [Interest at which HFC raises funds]
When homebuyer is unable to meet his interest payment obligations, the house would act as collateral and the HFC would mark that loan as an NPA. So the main risk comes from a homebuyer unable to meet his interest payment obligations. Hence, riskier homebuyers (typically self employed) get loans at higher interest while safer homebuyers (typically salaried) get loans at lower interest.
There are other factors which influence the interest rate too, like RBI repo rate. If RBI repo rate is lower, then the prevailing market interest rates also would be lower and hence the homebuyer gets his loan at a lower interest rate. Similarly if RBI rate repo rate is higher, then the homebuyer gets his loan at a higher interest rate. However as investors of HFCs, what we need to care about is the spread. RBI repo rates influence both the interest rates i.e. interest at which the HFC lends and the interest at which the HFC raises money.
The housing loan market is really huge. AUM of the industry is Rs 22.26 lakh crores and grew 10% in FY21 despite COVID. At the same time, this industry has a huge scope for growth. There are lots of homeless families in the country and lots of scope for people with homes to upgrade their homes. Houses in developed countries are lot more superior as compared to houses in India. As India grows, its citizens would aspire to upgrade their homes similar to how they are in the developed economies. Also lifetime of a home is typically 30 years. So once a home is bought by a family, it doesn’t necessary mean that the family is lost as a customer to the industry forever. Their kids need to build their own house as they will have to renovate / buy a new house after 30 years. So there is a repeat business element in this industry, albeit with high amounts (as homes are expensive) and long cycles (as homes lifetime is huge).
Why is HDFC special in HFC business?
HDFC Ltd is a pioneer in Housing loans business in the country. It’s prudent culture has ensured that it withstood many ups and downs in India’s economic history since 1977. Since inception, written off loans (net of subsequent recovery) aggregates to Rs 3366 crores as of 31st March 2021, which is just 21 bps of cumulative disbursements since inception of the Corporation.
HDFC’s prudence is also reflected in its cost of funds throughout market cycles. During market turbulence, most investors turn to HDFC as flight for safety. These numbers speak a lot more about HDFC’s prudent lending than my words.
GNPAs have always been low at ~1% through out the past bunch of years. However currently Proforma GNPAs rose to 1.98% owing to COVID uncertainties. These loans are more than sufficiently provisioned by the management.
In lending businesses, companies which survive turbulence of the previous cycle end up gobbling up higher share in the next cycle as they eat into the share of companies which were struck poorly in the previous cycle. HDFC has been a beneficiary of this trend since decades.
HDFC Chairman Deepak Parekh is one of the most respected businessmen in the country. He is called upon during almost every financial crisis the country faces (IL&FS Crisis, Yes Bank Fiasco…). This reflects how well respected he is by the industry. All the subsidiaries / associates of HDFC Ltd (HDFC Bank, HDFC AMC, HDFC Life, HDFC Ergo…) are respected in similar fashion and are richly valued by the stock market.
Why HDFC Ltd now?
With inflation spiking up around the world, one needs to be careful on how they manage their investments. Anyone who has done a basic research on the 1970s Great Inflation in the US would have realized that Real Estate market gets really hot during high inflationary periods.
Hot real estate market catches every ones interest and would encourage people to buy homes raising money from Banks and HFCs. This would lead to increase in demand for home loans. Hot real estate market and inflation would also mean that the ticket size of those loans would increase too. So the benefits of inflation are two-fold to HFCs.
The industry was going through a tough time since the ILFS crisis. HDFC has become very cautious and didn’t grow their non-individual loan book. Non-individual loan book typically comprises of Construction Finance, Lease Rental Discounting. These are relatively more risky due to their ticket size, risk of completion of the construction project. With all the issues in past 4 years behind us (RERA, GST, IL&FS, COVID) and poor loans provisioned appropriately, I think HDFC is ready to grow the non-individual loan book too.
Due to above factors, I think HDFC Ltd is ready for the next wave of growth. Part of it is also reflected in its disbursals growth in past few quarters was COVID impact was minimal (42% in Q3FY21, 60% in Q4FY21).
Business Metrics:
| 2021 | 2020 | 2019 | 2018 | 2017 | ||
|---|---|---|---|---|---|---|
| AUM (crores) | 569894 | 516773 | 461913 | 402880 | 338478 | |
| AUM Growth | 0.1 | 0.12 | 0.15 | 0.19 | 0.16 | |
| NIM | 3.50% | 3.40% | 3.30% | 4.00% | 3.10% | |
| Cost to income | 7.70% | 9% | 8.90% | 9.20% | 7.40% | |
| Spread | 2.29% | 2.27% | 2.30% | 2.29% | 2.33% | |
| Yield | 8.99% | 10.18% | 10.29% | 9.76% | 10.64% | |
| Cost of funds | 6.70% | 7.91% | 7.99% | 7.47% | 8.31% | |
| GNPA | 1.98% | 1.99% | 1.18% | 1.11% | 1.02% |
| AUM Breakup | 2021 | 2020 | 2019 | 2018 | 2017 | |
|---|---|---|---|---|---|---|
| Individual Loans | 0.74 | 0.72 | 0.71 | 0.7 | 0.72 | |
| Corporate Bodies | 0.25 | 0.26 | 0.27 | 0.28 | 0.26 | |
| Others | 0.01 | 0.02 | 0.02 | 0.02 | 0.01 | |
| Total | 1 | 1 | 1 | 1 | 0.99 |
| Loan Sourcing | 2021 | 2020 | 2019 | 2018 | 2017 | |
|---|---|---|---|---|---|---|
| HDFC Sales | 54% | 54% | 54% | 51% | 50% | |
| HDFC Bank | 27% | 26% | 26% | 27% | 25% | |
| Other DSAs | 17% | 17% | 16% | 16% | 18% | |
| Direct Walk-ins | 2% | 3% | 4% | 6% | 7% | |
| Total | 100% | 100% | 100% | 100% | 100% |
Subsidiaries:
Top subsidiaries are HDFC Bank (owns 21.1%), HDFC Life (owns 49.97%), HDFC AMC (owns 52.7%) and all of them are listed. I would suggest to go through their threads in the forum to understand them further.
HDFC Bank => HDFC Bank- we understand your world
HDFC Life => HDFC Life Insurance Company
HDFC AMC => HDFC Asset Management Company
There is another subsidiary which is reasonably sized, HDFC ERGO. This is the general insurance arm of HDFC Group and could likely be listed in the market after 3-5 years.
Financials & Valuation:
| 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | ||
|---|---|---|---|---|---|---|---|
| Interest Income | 42771.96 | 42647.12 | 39240.24 | 33133.08 | 32111.06 | 29257.31 | |
| Investment Profits | 2351.97 | 12677.9 | 1830.85 | 5718.25 | 1001.73 | 1647.81 | |
| Other Revenue Sources | 3051.93 | 3438.32 | 2306.92 | 1856.16 | 46.81 | 51.45 | |
| Total Revenue | 48175.86 | 58763.34 | 43378.01 | 40707.49 | 33159.6 | 30956.57 | |
| Finance Cost | 28614.76 | 31001.36 | 27837.67 | 23497.98 | 20896.2 | 19374.51 | |
| Impairment | 2948 | 5913.1 | 935 | 2115 | 700 | 715 | |
| Employee benefits | 914.11 | 592.92 | 716.53 | 1372.09 | 388.8 | 349.09 | |
| D&A | 158.78 | 147.74 | 66.53 | 49.24 | 55.96 | 54.28 | |
| Establishment expenses | 32.52 | 40.37 | 107.57 | 100.02 | 86.22 | 84.19 | |
| Other expenses | 692.6 | 716.93 | 595.94 | 383.52 | 305.78 | 271.4 | |
| PBT | 14815.09 | 20350.92 | 13118.77 | 13189.64 | 10726.64 | 10108.1 | |
| PAT | 12027.3 | 17769.65 | 9632.46 | 10959.34 | 7442.64 | 7093.1 |
The financials look lumpy due to the listing of their HDFC Life, HDFC AMC subsidiaries and Bandhan-GRUH merger over the past few years. And hence P/E ratio across past few years would look lumpy too.
So let’s go with SOTP valuation.
21.1% of HDFC Bank => 1.65 lakh crores
49.97% of HDFC Life => 0.67 lakh crores
52.7% of HDFC AMC => 0.32 lakh crores
Other subsidiaries are very small, but lets assume they make up 0.1 lakh crores together.
So total subsidiaries value is ~2.75 lakh crores.
After discounting by 30% (holding co. discount), it is 0.7 * 2.75 lakh crores ~ 1.9 lakh crores.
Current Market Cap of HDFC Ltd is 4.4 lakh crores.
This implies that the housing finance business is valued at (4.4 - 1.9) lakh crores ~ 2.5 lakh crores.
Standalone PAT is 12000 crores (There are no listings / mergers in FY21).
Standalone Book Equity is 1.1 lakh crores.
Above numbers imply P/E ~ 20.8 & P/B ~ 2.3 on standalone business.
In my opinion, these are reasonably cheap multiples given the opportunity ahead of us.
Risks:
- Change in culture => HDFC’s strength lies in its culture of prudence and risk management. We have to keep our eyes open to check if this is changing. If short-term growth driven by greed takes over the current culture, then we will have to reevaluate our investment thesis
- Greedy DSAs => Lenders are susceptible to losing their existing customers to other players who often lure them through lower interest rates or increased loan amounts. As there are no prepayment penalties on floating rate loans, a lender can take over a home loan rather effortlessly. DSAs are happy to play along as it means getting paid a commission twice over on the same borrower’s loan.
- Patience => It may take some more time for the growth cycle in HFC business to pick up. So one may have to wait longer than they anticipated and investors should be mentally prepared in this regard.
Disclosure:
No holdings, but seriously considering to invest. I’m not a SEBI registered investment advisor. Please consider me a novice and consult your investment advisor before investing / trading in this stock.
