>Housing Development Finance Corporation Ltd.

India’s low mortgage penetration rate & favourable
demographics leaves sufficient room for growth…

Expected benefits of more stable & predictable business
model vis-à-vis peers already factored into stock price…

WHAT HAPPENED LAST QUARTER....

HDFC Ltd.’s (HDFC.IN)/ (HDFC.BO) reported numbers for Q1 FY11 came in marginally lower
than our expectations. HDFC reported an EPS of Rs.23.5 for the quarter, as against our estimate of Rs.24.1, mainly due to a decline of 15% Y-o-Y and 13% sequentially in the Non Interest Income to Rs.1.85 bn. The net interest income grew 34.2% Y-o-Y, but fell 21% sequentially to Rs.8.97 bn in Q1 FY11. Interest expenses increased 10.3% sequentially, which was in line with our expectation (in our various sector reports published since January 2010, we had highlighted that the low interest rate regime would be history and with the RBI continuing to exit from its accommodative monetary policy, there could be an increase in the cost of funds for banks/ NBFCs). In Q1 FY11, the operating income increased 22% Y-o-Y, but declined 19% sequentially to Rs.10.8 bn. However, an increase of 9% Y-o-Y and 57% sequentially in operating expenses resulted in the operating profit rising 24% Yo-Y, but declining 23.6% sequentially to Rs.9.7 bn in the quarter. HDFC’s spread on loans expanded by 3 bps sequentially to 2.34%, on account of its policy of passing on incremental costs to buyers.

HDFC’s loan book grew 16.7% Y-o-Y to Rs.1,016.2 bn (net of loans sold). The “individual loans”
category (comprising 63% of outstanding loans and hence, acting as the key growth driver of
HDFC’s loan book) grew 16.9% Y-o-Y to Rs.641 bn, while loans to corporate bodies were up 18%
Y-o-Y to Rs.360 bn in Q1 FY11. HDFC’s asset quality remained superior, with the Gross NPA
declining 9 bps Y-o-Y to 0.89% in Q1 FY11. Unrealised gains on listed investments amounted to
Rs.167.75 bn in Q1 FY11, as against Rs.116.62 bn in Q1 FY10 (excluding the appreciation in the
value of unlisted investments). HDFC’s capital adequacy ratio stood at 14.8%, while the Tier-I
capital adequacy was 13.6% in Q1 FY11.

Going forward, India’s low mortgage penetration (around 7% of the nation’s GDP in FY10) and
favourable demographics, with nearly 60% of the country’s population below 30 years of age, leaves sufficient room for growth. Management expects HDFC’s disbursements to grow 20-
25% in FY11 and believes that the company will continue to pass on any increase in interest
rates to its buyers and maintain a spread of around 2%. However, HDFC’s life insurance
subsidiary (HDFC Standard Life) could witness delays in terms of break even and listing plans,
following the regulatory changes in guidelines.

Management is also considering new growth avenues. For instance, on July 9, 2010, HDFC
bought an additional 4.028 mn shares of Credila Financial Services, a specialized education loans provider, for Rs. 40.3 mn. Following the acquisition, HDFC's stake in Credila will increase to 51%. HDFC’s business model is certainly more stable and predictable than that of almost any other financial services company in India, though we believe that this is probably already factored into the stock price. In light of these developments, we expect HDFC to post an EPS of Rs.26.2 in Q2 FY11 and Rs.111.5 for FY11. The stock currently trades at a P/E multiple of 26.7x of FY11 (E) earnings and a P/BV of 4.8x FY11 (E) book. We reiterate our rating of Market Perform on HDFC.

To read the ful report: HDFC