HDFC LTD (HDFC) : Never Out of Gear

Initiating Coverage
March 28, 2012

Rating Matrix
Rating Target Target Period Potential Upside : : : : Hold | 719 12 months 8%
HDFC Ltd (HDFC)

Never out of gear
| 667
HDFC , the market leader in Indian Housing finance market with ~17% market share is expected to leverage the humungous opportunity presented by the underpenetrated Indian mortgage finance industry. Resilient asset quality and low volatility in spreads has enabled the company to achieve a healthy CAGR of 21% in loans and 23% in net profit over the previous five years. We expect HDFC to continue with its strong asset quality profile and spreads which would enable it to maintain its growth trajectory going ahead. HDFC, through its subsidiaries and associate companies has a presence in the Mutual Fund, Life and general insurance segments which would enable it to cross sell its products and mine its existing customer base across various business verticals thereby adding value to the core business.
YoY Growth (%)

(%) NII PPP Net Profit EPS FY11 25.4 21.6 25.1 22.4 FY12E 22.4 28.4 17.3 16.8 FY13E 22.0 27.2 19.0 14.7 FY14E 21.2 25.5 18.6 18.6
Stock Data
Bloomberg/Reuters Code Sensex Average volumes (lacs) Market Cap (| crore) 52 week H/L Equity Capital (|crore) Face Value (|) FII Holding (%) DII Holding (%) HDFC IN/HDFC NS 17,257.0 51.0 98,513 736 / 601 294.8 2.0 66.2 20.3
Indias under-penetrated market to offer long-term growth visibility

Mortgages as a percentage of GDP in India are just 9% compared to developed countries where it is above 80% and China where it is 20%, providing long-term visibility for growth. We expect HDFCs loan book to witness a healthy CAGR of 20% over FY12-14E to | 1995 billion.
Volatility in spreads contained

HDFC has been able to minimise deviation in reported spreads by maintaining it in the range of 2.15% to 2.35% in the past five years despite volatile interest rates owing to its flexible borrowing profile and stable asset-liability management. We expect FY13E calculated adjusted spreads to be stable at 2.9% as compared to 2.83% in FY11.
Comparable return matrix (%)

Return % HDFC Ltd LIC Housing Finance Dewan Housing SBI 1M 0.5 7.1 -8.8 0.2 3M 0.1 16.8 18.7 29.6 6M 4.1 23.6 4.5 6.7 12M 0.6 27.4 3.6 -21.4
Seasoned loan portfolio, nil NNPA

HDFCs assets are seasoned and have witnessed various cycles still maintaining resilience with nil NNPA and 0.8% GNPA as on FY11. Going forward, we expect the asset quality to remain strong with GNPA of 0.9% and nil NNPA for FY13E owing to its strong in-house recovery team.
Price movement
6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 Apr-11 Jul-11 Price (R.H.S) Sep-11 Dec-11 Nifty (L.H.S) 800 700 600 500 400 300 Mar-12
Well established subsidiaries to add to future profit & valuation

HDFC has three major subsidiaries viz. HDFC Standard Life, HDFC Asset Management and HDFC ERGO General Insurance and an associate HDFC Bank all already having a strong foothold and market share in India.
Valuation
HDFCs consistent track record in earnings and business growth has led to healthy return ratios averaging RoE of 22% and RoA of 2.8% and we expect the same to be maintained. We have valued HDFC on an SOTP basis arriving at a target price of | 719. We initiate with a HOLD rating.
Exhibit 1: Key Financials (Standalone) Year to March FY10 Net Profit (| crore) 2826.5 EPS (|) 19.7 Growth (%) 22.7 P/E (x) 33.9 Price / Book (x) 6.3 Price / Adj Book (x) 6.4 GNPA (%) 0.8 NNPA (%) 0.1 RoNA (%) 2.6 RoE (%) 20.0
Source: Company, ICICIdirect.com Research
Analysts name
Kajal Gandhi kajal.gandhi@icicisecurities.com Vasant Lohiya vasant.lohiya@icicisecurities.com Jaymin Trivedi jaymin.trivedi@icicisecurities.com
FY11 3535.0 24.1 22.4 27.7 5.7 5.7 0.8 0.0 2.8 21.7
FY12E 4148.1 28.1 16.8 23.7 5.3 5.3 0.8 0.0 2.8 22.9
FY13E 4935.9 32.3 14.7 20.7 4.2 4.2 0.9 0.0 2.8 22.8
FY14E 5854.5 38.3 18.6 17.4 3.8 3.9 0.9 0.1 2.9 22.8
ICICI Securities Ltd | Retail Equity Research
Page 1
FII & DII holding trend (%)

70 60 50 (%) 40 30 20 10 0 Q4FY11 Q1FY12 Q2FY12 FIIs DIIs Q3FY12 Q4FY12* 29 29 29 29 20 59 58 58 59 66
Company Background
Incorporated in 1977 as the first specialised mortgage company in India, HDFC Ltd is now the leading housing finance company in India with | 1322 billion of loans outstanding as on Q3FY12 translating into a market share of ~17.5%. The company, as on FY11, has disbursed | 3025 billion and sanctioned | 3732 billion towards home financing since its inception. The companys core business is to provide loans for purchase or construction of residential houses, home improvement, home extension and short-term bridging loans to individuals. HDFC also provides loans to corporations and real estate developers. The company has a pan-India network of 304 outlets including 74 outlets belonging to its wholly owned distribution company. The company has financed 3.9 million housing units since its inception. However, over a period of time, HDFC has also emerged as a financial conglomerate with interests beyond mortgages. The companys major subsidiaries and associates include HDFC Bank, HDFC Standard Life Insurance, HDFC AMC, HDFC ERGO General Insurance, Gruh Finance, HDFC Property Ventures, HDFC Venture Capital and Credila Financial Services. HDFC has a track record of consistent growth in business, strong asset quality, stable margins, excellent operating efficiency, ability to raise funds easily and healthy return ratios, which enable it to command high valuations.
Source: Company, ICICIdirect.com Research , *As on Mar 02,2012
Q4FY12* Shareholding pattern (%)

Promoter Foreign Institutional Investors (FII) Domestic Institutional Investors (DII) General Public 0.0 66.2 20.3 13.5
*As on March 02, 2012
Exhibit 2: HDFCs subsidiaries and associates
HDFC
HDFC Bank 23.2%

s
HDFC Standard Life 72.4%
HDFC Asset Management 60%
HDFC ERGO General 74%
GRUH Finance 60.4%
HDFC Property Venture 100%
HDFC Venture Capital 80.5%
Credila Financial Services 62.3%
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Exhibit 3: HDFC core business model (data as on Q3FY12)

Borrowings: i) Bonds & debentures ii) Deposits iii) Domestic term loans
53% 27% 19%
304 outlets including 74 outlets of wholly owned distribution company Deposits & loan products offered in over 2400 towns & cities Sourcing of business: i) HDFC Bank ii) HDFC Sales Pvt Ltd iii) Direct walk-ins iv) Other DSAs
Home financing catering to: i) Individuals (67% of the book) ii) Corporates incl. real estate developers (33% of book)
HDFC Ltd
29% 46% 14% 11%
Strong and experienced management
Exhibit 4: Management team

Name Designation Remarks Mr Parekh joined the company in a senior management position in 1978. He is a pioneer in the Indian housing finance industry. He is a Fellow of the Institute of Chartered Accountants (England & Wales) He has been with the company since 1981. He is a Fellow of the Institute of Chartered Accountants of India. He has been re-appointed as Managing Director (designated as the 'Vice Chairman & Chief Executive Officer') of the company for five years, with effect from November 14, 2010 He joined the company in 1986. He was the senior general manager - Corporate Planning & Finance funtion at head office since 2000. He is an associate member of ICAI and ICWA of India. He has been appointed as ED of the company for five years with effect from Januray 1, 2010. She has been with company since 1978. She is a graduate in law from University of Mumbai and holds a Masters degree in economics from University of Delhi. She has been appointed as the Managing Director of the company for five years with effect from January 1, 2010
Deepak Parekh
Chairman
Keki Mistry
Vice Chairman & CEO
V Srinivasan Rangan
Executive Director
Renu Sud Karnad
Managing Director
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Investment Rationale
Opportunity for mortgage finance industry remains huge.
There continues to remain huge potential for growth of the Indian housing finance industry. This is evident from the fact that mortgage as a percentage of Indias GDP at 9% remains one of the lowest in the world. The corresponding figure for developed countries like the US and UK stands at 81% and 88%, respectively, while for China it is at 20%.
Exhibit 5: India - under-penetrated mortgage finance market
120 100 80 60 40 20 0 88 104
Exhibit 6: Trends in Indias mortgage as a percentage of GDP

10 8 (%) 6 4 2 6.6 8.1 8.8 8.9 9.0 9.1 9.1
81 29 32 39 41 48
(%)
9 India
17
20
26
Thailand
Germany
HK
Singapore
China
Korea
Malaysia
Taiwan
UK
Denmark
USA
0 FY05 FY06 FY07 FY08 FY09 FY10 FY11
Mortgage as a % of GDP
Mortgage as a % of GDP(Nominal) of India
Source: Company Presentation, ICICIdirect.com Research
Source: Company, CSO, ICICIdirect.com Research
Size and market share dynamics of housing finance industry in India

The size of the Indian housing finance industry in terms of loan outstanding and loan disbursement is | 6640 billion and | 1672 billion, respectively, as on FY11. The five year CAGR in loan outstanding and disbursements has been healthy at 19.5% and 14%, respectively. The industry is quite competitive with 53 registered housing finance companies (HFCs) and various scheduled commercial banks (SCBs). However, the top five or six players like HDFC Ltd, SBI, ICICI Bank, LIC Housing Finance, Dewan Housing Finance and ICICI Home Finance account for more than 50% (refer Exhibit 9). The share of SCBs has increased from 31% in FY00 to 64% as on FY07 mainly on the back of their increased focus on the home finance business, access to low-cost deposits and wider reach. However, HFCs have been able to improve their share to 51% as on FY11 from 36% as on FY07 (refer Exhibit 10) mainly due to their dedicated business line, improved service level and banks going slow on housing finance during the slowdown of FY08-09.
Exhibit 7: Industry loan grows at healthy CAGR of 19.5%...
7000 6000 5000 4000 3000 2000 1000 0 6640 30.3 5588 27.6 3483 4070 4765 17.1 16.9 17.3 35 30 25 18.8 20 15 10 5 0
Exhibit 8: ...while disbursements witness 14% CAGR over FY06-11

2000 1500 (| bn) (%) 1000 500 0 FY06 FY07 FY08 -1.5 FY09 FY10 86013.0 8.3 27.1 1097 1188 1170 23.2 1441 1672 30 25 20 16 15 10 5 0 -5
(| bn)
FY06
FY07 Loans
FY08
FY09
FY10
FY11E
FY11E
Loan Growth (RHS)
Disbursements
Disbursements Growth (RHS)
Source: CRISIL Research, ICICIdirect.com Research
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(%)
2729
Exhibit 9: With 17.6% market share as on FY11, HDFC leads housing finance business in India
3.0 7.7 1.3
17.6
8.1
HDFC LTD
SBI
ICICI Bank
13.1 LIC Housing Finance Dewan Housing Finance
ICICI Home finance

HFCs have managed to increase their share to 51% as on FY11 from 36% in FY07
Exhibit 10: Trends in HFCs and SCBs disbursements market share

120 100 80 (%) 60 40 20 0 FY07 FY08 FY09 HFCs FY10 SCBs FY11 FY12E 36 44 48 48 51 52 64 56 52 52 49 48
Major structural drivers of housing finance industry in India remain intact...

The major drivers of the housing finance industry in India as stated below remain intact: Large population with a favourable demographic profile wherein 65% of the population is below 35 years Rising and high disposable income with high propensity to spend on assets like real estate for shelter as well as for investments Increasing urbanisation currently only 31% of the population resides in urban areas Nuclearisation of families leading to higher demand for houses Due to demand-supply mismatch, the total housing shortage is ~88 million as on FY11, of which urban housing shortage is 28.9 million (as per Crisil Research) Tax incentives available in the form of deduction of interest and principal repayments, which results into lower effective interest rates borne by the borrower Improved affordability (refer Exhibit 14)
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Exhibit 11: Demographic profile as on FY11
Exhibit 12: Demographic profile as on FY16E

5 1
51 29 39
31
36
26
27
0-19 20-34 35-64 65-79 80+
0-19
20-34
35-64
65-79
80+
Source: Ministry of Home Affairs, ICICIdirect.com Research
Source: Ministry of Home Affairs, ICICIdirect.com Research
Total ~75% of HFCs business comes from urban areas. With urbanisation set to witness a rising trend reaching 34% by FY16 (as per Crisil Research) of total population, we believe the penetration opportunity for HFCs remains strong
Exhibit 13: Urbanisation trends in India

35 30 25
(%)
46.1 41.4 32.0 19.1 13.9 12.0 17.3 26.4 19.9 18.0 38.2 23.3
15 10 5 0 10.3 0.4 1911 1921 11.2 8.3
1931
1941
1951
1961
1971
1981
1991
2001
2011
Percentage of urban population to total population
Decadal growth in urban population
Source: NHB, ICICIdirect.com Research

Despite rising property prices over the last decade, the affordability of the Indian household has improved owing to rising income and propensity to spend
Exhibit 14: Rising income and affordability

45 40 35 30 25 20 15 10 5 0
FY95
22 15.6 11.1 8.3 6.6

FY00
5.9
FY01
5.3
FY02
5.1
FY03
4.7
FY04
4.3
FY05
4.7
FY06
5
FY07
5.1
FY08
5.1
FY09
4.5
FY10
9 8 7 6 5 4 3 2 4.7 4.8 1 0
FY11
FY96
FY97
FY98
Property Cost (| Lakh)
FY99
Annual Income (| Lakh) (RHS)
*Affordability (x)
Source: Company presentation, ICICIdirect.com Research * Affordability equals property prices divided by annual income
Page 6
(%)
20
50 45 31.2 40 36.4 27.8 35 25.7 31.5 31.830 25 20 15 10 5 0
With the urban population set to rise to 34% by FY16E, the urban housing shortage will increase to 31.9 million units
Exhibit 15: Trends in urban and rural housing shortage

80 70 60 mn units 50 40 30 20 10 0 FY01 FY05 FY08 FY11 Rural Housing Shortage FY16E 12.8 22.1 24.6 28.9 31.9 71.4 68.9
62.2
59.2 51.0
Urban Housing Shortage
Housing finance industry is expected to witness CAGR of ~17% over FY12-14E to | 10780 billion
All the above factors make us believe that despite some slowdown in the economy the demand for housing, housing finance and the business potential of the housing finance industry per se remains strong and is visible as the market is under penetrated. The growth for HFCs during FY11-12E is expected to be slower than the previous year mainly due to higher property prices and interest rates along with a slowdown in the economy. With interest rates peaking, the housing finance industry is expected to witness a CAGR of ~17% (as per Crisil Research) over FY1214E to | 10780 billion.
Page 7
Growth momentum to continue as market leader.

HDFC Ltd is a leading company in the Indian housing finance industry with a market share of 17.6% in loans outstanding and 36% in loan disbursements as on FY11. The companys loan book as on Q3FY12 stood at | 1322 billion with 3.9 million housing units financed since inception. Loans have grown at a healthy CAGR of 21% over FY06-11, which is above the industry growth of 19.5% over the same period. Despite the economic slowdown in FY08-09, increasing competition from banks and other HFCs and volatile interest rate cycles, the company has been able to maintain its share. We expect HDFCs loan portfolio to witness growth at a CAGR of 20% over FY12-14E to | 1995 billion.
Exhibit 16: Trends in HDFCs loan outstanding
2000 1500 (| bn) 1000 500 0 FY09 FY10 FY11 FY12E FY13E 852 980 16.2 19.6 15.0 1171 1394 19.0 19.1 1661 25 20 (| bn) (%) 15 10 5 0
Exhibit 17: Trends in HDFCs disbursements

1000 800 600 400 200 0 FY09 FY10 FY11 397 20.6 504 27.1 830 603 19.6 16.5 FY12E FY13E 703 18.1 29.0 27.0 25.0 23.0 21.0 19.0 17.0 15.0
Loans Outstanding
Loans Outstanding Growth YoY (RHS)
Disbursement
Disbursement Growth YoY (RHS)
Exhibit 18: HDFC's market share trend over FY06-11

19 18 18 18.0
17.9 17.5
17.6
17.7
We expect HDFC to maintain its market leading share, going forward
(%)
17 17 16 16 15
16.5
16.2
FY06
FY07
FY08
FY09 HDFC Market share
FY10
FY11
FY12E
Source: Company, CRISIL Research, ICICIdirect.com Research
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(%)
Diversified loan book supports margins

HDFC has always maintained a diversified loan book with loans to individuals comprising 66% and loans to corporates comprising 33% of total loans as on FY11. Loans to individuals amounting to | 773 billion are mainly (>90%) towards salaried employees while the balance is to professionals. Loans to corporates to the tune of | 386 billion as on FY11 includes loans given to companies for purchase of commercial properties, rental discounting and also includes loans to real estate developers, which comprises ~12% of total loans. HDFC has guided that, going forward, it will maintain a loan mix structure of 65% individual and the balance corporate loans. Loans to individuals have slightly lower yields than loans to corporates, which is compensated by lower delinquencies in the individual loan portfolio wherein the chances of default are lower as the property financed is the primary security. Further, in India, majorly property is purchased for personal use and not for speculation and early repayments is also higher.
Exhibit 19: HDFCs loan mix mainly skewed towards individual housing loans
The management has indicated that individuals and corporates loan mix of 65:35 will be maintained, going forward
120 100 80 (%) 60 40 20 0 FY07 FY08 FY09 Individuals FY10 FY11 Others 9MFY12 66 66 64 63 66 67 2 32 3 32 2 33 2 36 1 33 1 32
Corporate Bodies
The individual loan portfolio has witnessed a healthy CAGR of 19% over FY06-11 while the corporate loan portfolio has grown at a strong rate of 25% over the same period. We are factoring in a CAGR of 20% for both individuals and corporate loan portfolio over FY12-14E to | 1995 billion.
Exhibit 20: Trend in growth rates of individual and corporate loans
35 30 25 (%) 20 15 10 5 0 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E 13.5 11.7 27.8 23.5 29.4 29.5
23.0
23.6 20.0 20.1 9.0
25.0
19.8 18.8
20.5 20.0
Individual loans Growth YoY
Corporate loans Growth YoY
Page 9
We expect HDFC to grow higher than industry loan growth
The management has indicated that major growth will come from the Delhi NCR region and Chennai. Growth from Mumbai has slowed down due to higher prices and project delays. We expect HDFCs loan portfolio to witness a CAGR of 20% over FY12-14E to | 1995 billion above the forecasted industry growth of ~17% (as per Crisil Research) owing to its strong franchise, brand pedigree, in-house model, efficient service level, dedicated business, stable and experienced management (average tenor of senior management in HDFC over 25 years), deep understanding of the mortgage market in India and peaking of interest rates and property prices. HDFC sells loan to banks as they need to meet priority sector credit targets. Accordingly HDFC has sold | 13484 crore as on Q3FY12 and includes loans sold to HDFC bank also. Such visibility in business growth in an uncertain environment makes HDFC a preferred bet.
Page 10
Healthy margins to remain stable

HDFC has a healthy track record of sustaining spreads and NIMs above 2% and 3.5%, respectively, across volatile interest rate cycles. One of the key reasons apart from flexible borrowing profile, higher credit rating and stable asset-liability management (ALM) is ~1.5-1.6% spread earned on loans sold to banks.
Spreads have remained healthy despite a volatile interest rate environment in the past
Exhibit 21: Trends in NIMs and spreads

5 4 3.9 3.3 3.2 2.5 2.7 2.6
3.6
3.5 3.0
3.8 3.5
3.9 3.6
4.1 3.6
4.1 3.5
(%)
3
2 1 0
2.8
2.8
2.9
3.0
FY08
FY09
NIM
FY10
FY11
Spreads
FY12E
FY13E
FY14E
Adjusted Spreads*
Source: Company, ICICIdirect.com Research, *Adjusted spreads are after considering redemption premium on ZCBs and interest earned on loans sold.
As on 9MFY12, the proportion of bonds and debentures increased to 53% from 42% as on FY11 while the proportion of domestic term loans declined to 19% as against 36% as on FY11.
HDFCs funding profile of | 1154 billion as on FY11 is diversified with bonds and debentures comprising 42% and domestic term loans comprising 36% while deposits account for 21%. However, over the past six quarters, banks have raised their base rates by ~250-300 bps after the RBI increased policy rates by 375 bps. Consequently, HDFC has adopted the strategy of raising more of low cost wholesale funds than going for bank term loans. As on 9MFY12, the proportion of bonds and debentures increased to 53% from 42% as on FY11 while the proportion of domestic term loans declined to 19% as against 36% as on FY11. We have factored in a growth of 17% CAGR in borrowings over FY12-14E, with major concentration towards wholesale borrowings.
Exhibit 22: Trends in HDFCs borrowing mix
With peaking of interest rates, HDFCs wholesale funded nature augurs well for its margins
120 100 80
(%)
3 39 18 40
3 29 17
3 28 23
2 32 24 42
1 36 21 42
1 19 27
60 40 20 0 FY07
51
46
53
FY08
FY09 Deposits
FY10 Domestic Term Loans
FY11
9MFY12
Bonds & Debentures
International Borrowings
This flexibility and diversification in the borrowing mix enables HDFC to raise funds easily to suit its need and also at lower rates compared to its peers owing to its strong brand pedigree, size and credit rating.
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Redemption premium charged to securities premium provide fillip to NIM

HDFC has ~| 70 billion of zero coupon bonds (ZCBs) on its balance sheet as on FY11 on which proportionate premium payable on redemption amounting to | 532 crore is charged to securities premium account and not to the profit and loss (P&L) account. HDFC has investments of~| 78 billion in its subsidiaries. The proportionate share of the income of subsidiaries does not form part of HDFCs total income. Hence management believes, charging redemption premium to HDFCs P&L account would give a distorted picture. As NIM doesnt adjust the same, its slightly higher than peers. If we exclude the benefit the impact is ~5060bps on NIM which then makes it marginally higher than the peers as compared to reported large gap as seen now. We have charged Securities Premium account with | 720 crore of interest at the rate of ~9% on | 80 billion of ZCBs for FY12E and FY13E and adjusted the spreads calculation accordingly. These ZCBs will be continuous funded by fresh ZCBs as and when matured until the management decides to treat the premium separately. We have calculated HDFCs adjusted spreads after deducting redemption premium on ZCBs and after deducting interest earned at ~1.6% on loans sold (securitised). On the asset side, as stated above, 66% of the exposure as on FY11 is towards individuals within which ~85-90% loans are on a floating rate basis. In contrast, the entire exposure towards corporates including real estate developers (12% of total loans) is high yielding and on a floating rate basis. Such a lending profile augurs well for the companys margins as it gives the company the ability to pass on interest rate hikes to customers. This is evident from the fact that it has increased its lending rates by 275 bps over the last five or six quarters and maintained business growth of ~20%. HDFCs ALM portfolio is well matched with ~80% of the liabilities and assets on a floating rate basis. As on Q3FY12, HDFC had securitised loans amounting to | 135 billion (9.3% of the loan book) on which ~1.5-1.6% spread is earned over the life of the loan.
We expect HDFCs NIM to rise by 12 bps to 4.1% as on FY13
If we exclude the benefit the impact is ~50-60bps on NIM which then makes it marginally higher than the peers as compared to reported large gap as perceived now.
Going forward, we expect calculated adjusted spreads to remain stable at 2.9% and NIM to increase 12 bps to 4.1% due to rate cuts by the RBI and also due to the fact that housing finance companies should perform better than banks while interest rates decline. Relative to cost of funds, wholesale borrowing by finance firms allows them to adjust price faster giving them a competitive advantage against banks. Further, in Q1FY13, ~| 220 billion of HDFCs teaser loan portfolio will get reset to floating rates, which will be 100-150 bps higher. This will further enhance NIMs.
Exhibit 23: Floating rates (%) charged by HDFC
Particulars < or = | 30 lacs > | 30 lacs and < or = | 75 lacs > | 75 lacs HDFC 10.75 11.0 11.5
Source: deal4loans.com, ICICIdirect.com Research
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Strong and resilient asset quality

HDFC has one of the best asset quality parameters in the industry. Its GNPA as on Q3FY12 is 0.8% while NNPA was nil on account of 100% provision coverage ratio. Q3FY12 was the 28th consecutive quarter end in which the percentage of non-performing loans has been lower than the corresponding quarter in the previous year. Provisions for contingencies as on FY11 were | 11.24 billion, which was 1.4x the regulatory requirement. Total loan write-offs are merely 0.04% of cumulative disbursements since inception. In Q1FY13, there will be a write-back of ~| 300 crore of provisions on teaser loans. The companys credit cost as on FY11 was 0.07%, which was lowest among industry peers. For FY13, we have a slightly conservative credit cost forecast of 0.13%.
HDFC has maintained a healthy asset quality in the past five years with GNPA below 1% and provision coverage ratio above 75%
Even during the crisis period of FY08-09, the asset quality did not deteriorate and remained stable at 0.8%.
Exhibit 24: One of the best asset quality in industry
0.9 0.8 120 90 (%) 60 0.2 0.1 0.0 FY08 FY09 Provision coverage (RHS) FY10 FY11 GNPA ratio 0.1 0.0 0.0 9MFY12 NNPA ratio 30 0
0.8 88.6
0.8 83.7
0.6 (%) 75.7 0.3
0.8 100.0
0.8 100.0
Exhibit 25: Credit cost expected to increase by 6 bps in FY12E

0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 0.13 0.13 0.13
Exhibit 26: Lowest credit cost among peers as on FY11

1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1.5
(%)
(%)
0.05
0.06
0.06
0.07
0.59 0.07 HDFC LICHF 0.15 DEWH Credit cost SBIN
FY08
FY09
FY10
FY11
FY12E
FY13E
FY14E
Credit cost
The key factor behind such a strong asset quality is HDFCs conservative lending policies, which enable it to avoid customers defaulting on loans. On an average, it lends only up to 66% of the assessed value of a property/asset.
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Average loan-to-value ratio at 66% compared to ~75% by others in the industry
Exhibit 27: Trends in loan-to-value ratio

68.5 68 67.5 67 66.5 66 65.5 65 64.5 64 63.5 68 67 66 65 68
(%)
FY08
FY09
FY10 Avg LTV at origination
FY11
FY12E
We expect HDFCs healthy asset quality to remain intact, going forward
HDFC has been able to reduce risk by: - Preventing aggressive loan growth or going for higher market share so as to maintain margins and asset quality - Of the total individual loan portfolio (67% of total loans as on Q3FY12), ~90% are salaried employees who are typically buying property for personal use and not for speculation. Also, the instalment to income ratio is lower. In case of most of the customers, post-dated cheques are obtained or deduction at source arrangements is done with employers - Exposure to real estate developers (12% of the total loan portfolio) is backed by collateral of 2.0x the loan size - The company has an experienced appraisal team, a strong in house follow up team and a cash flow based lending system We expect the asset quality to be healthy, going forward, with GNPA maintained at 0.8% and nil NNPA for FY13E.
Page 14
Best operating efficiency in the industry

HDFC has the best operating efficiency in the industry with cost-to income ratio at 7.7% as on FY11. Its peers like LIC Housing Finance and Dewan Housing Finance have a cost-to-income ratio of 14% and 46%, respectively while SCBs ratio is ~47%. This is mainly due to the in-house sourcing model of HDFC compared to the DSA based model (90%) of LIC Housing Finance and branch based model of Dewan Housing Finance. Further, the lower employee base of HDFC as compared to other HFCs and banks, enable the company to maintain such low ratios. Another important factor is that HFCs, in general, have low cost of operations as compared to banks owing to lower regulations (refer Exhibit 31) and number of branches to be maintained.
Exhibit 28: Continuously improving operating efficiency
35 30 25 20 15 10 5 0 30.9
Exhibit 29: No match for HDFCs operating efficiency (FY 11)

60 50 40 36.7 14.1 47.6 48.1
41.3
42.7
(%)
13.8
12
(%)
30 20 10 0 HDFC LICHF DEWH SBI PNB 7.7
9.2
8.8
7.9
7.7
7.1
7.1
FY90 FY00 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Cost-to-Income ratio Cost-to-Income ratio
HDFC Bank
Axis Bank
HDFC sources 29% of its loans from HDFC Bank and 46% from its wholly owned subsidiary HDFC Sales Pvt Ltd. HDFC adjusts commission expenses from fees & other charges line item as against including in the operating expenses. For FY11, commission expenses amounting to | 199 crore were netted off from fees & other charges under other income. According to our calculations, if we include commission expenses into operating expenses, the cost-to-income ratio rises to ~10.5% as on FY11, which is still below industry peers.
Total ~89% of the business is generated by itself or through its affiliates
Exhibit 30: Business sourcing profile as on Q3FY12

11
14 46
29 HDFC Sales Pvt Ltd HDFC Bank Direct Walk-ins Other DSAs
Page 15
Operating expenses as a percentage of average assets as on FY11 stood at 0.3% as against 0.5% for LIC Housing Finance and 1.6% for Dewan Housing Finance. Further, in terms of assets per employee and profit per employee, HDFC has observed a sharp improvement. For instance, HDFCs assets per employee have improved from $ 0.5 million in FY90 and $ 4.4 million in FY00 to $ 18.6 million as on FY11. Correspondingly, profits per employee have increased to $ 0.49 million as on FY11 from $ 0.12 million in FY00. We believe HDFCs cost-to-income ratio would be sustainable and have built in 7.1% for FY13E.
Exhibit 31: Lower employee base of HFCs result into lower cost-to income ratio (FY11)
1400 1200 1000
(| bn)
We forecast HDFCs remarkable operating efficiency will continue, going forward
1607 1171 1190 1137
800 600 400 200 0 HDFC 511
199 LICHF
Loans outstanding (| bn)
1800 1600 1400 1200 1000 800 600 400 200 0
DEWH
No of Employees (RHS)
Lower regulations and operating costs enable HFCs to maintain better operating efficiency compared to banks
Exhibit 32: Structural difference between HDFC Ltd and banks

HDFC Ltd. HDFC is mainly Wholesale funded No CRR requirement for HFCs HFCs are required to maintain a SLR of 12.5% in respect of public deposits raised. Bank Banks are funded by mix of borrowings and deposits Banks have to maintain 4.75% as CRR Banks have to maintain SLR of 24% of Net demand and Term liabilities (NDTL)
Banks must maintain 40% of adjusted bank credit as priority HFCs have no priority sector requirement sector requirement Lower operating cost on account of wholesale funded Higher operating cost on account of maintainance of branches structure for deposit collection
Source: NHB, RBI, ICICIdirect.com Research
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IFRS implementation to increase accounting profits

The management expects implementation of IFRS will enhance standalone accounting profits by 20 to 30% due to following differences between Indian GAAP and IFRS: 1. Under Indian GAAP investments are required to be reflected in the balance sheet at original cost unlike at fair value under IFRS. 2. Under Indian GAAP standalone accounts only reflect dividend paid by the subsidiary/associate companies and not the pro-rata share of profits. Under IFRS there is no concept of standalone financials. 3. Under Indian GAAP insurance companies are required to charge off acquisition costs upfront as against amortising the costs over the life of the policy under IFRS. 4. Commission paid on loan sourced through HDFC bank, HDFC sales private Ltd and other DSA agents are currently charged upfront under Indian GAAP. However under IFRS such commission expenses shall be amortised over the period of loan. 5. Under Indian GAAP interest earned (at the rate of ~1.5-1.6%) on loans sold is recorded every year. However under IFRS the present value of the interest to be earned on loans sold needs to be recorded upfront. Management expects IFRS to be implemented from April, 2014. However we have not factored in any impact of IFRS in our forecasts.
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Subsidiaries add to valuation

HDFC AMC maintains its profitability streak
HDFC AMC is the largest AMC according to latest AMFI data and has the highest equity proportion in total assets leading to better profitability. In FY11, AUM grew 2% YoY to | 89482 crore in-line with industry AUM. Within the same, equity AUM grew 30% YoY to | 34853 crore from | 26815 crore. It makes an annual profit of | 242 crore (FY11) and is a strong cash flow business. Higher the equity proportion of AUM, the greater the probability of better valuations since equity AUM provides better margins than the fixed income portfolio. This is mainly because a large part of the fixed income AUM is short-term in nature and remains volatile.
Exhibit 33: Equity proportion in total AUM distinguishes profit and valuation of players
AMC Name HDFC Asset Management Company Limited Reliance Capital Asset Management Limited ICICI Prudential Asset Management Company Limited Birla Sunlife Asset Management Company Limited UTI Asset Management Company Private Limited SBI Funds Management Private Limited Franklin Templeton Asset Management (India) Pvt Ltd DSP BlackRock Investment Managers Private Limited IDFC Asset Management Company Limited Kotak Mahindra Asset Management Company Limited Tata Asset Management Limited Sundaram Asset Management Company Limited Deutsche Asset Management (India) Private Limited Religare Asset Management Co. Private Limited Axis Asset Management Company Ltd. Total AUM (Cr.) Equity (Cr.) 90150.3 34474.5 83206.1 26460.0 68219.8 14192.3 60575.2 9322.5 58121.9 20982.6 42174.8 13454.0 31612.0 11890.2 29013.6 9494.1 25856.2 3680.8 24790.4 2613.7 19063.2 3986.2 13807.3 6177.4 13373.6 224.7 11922.2 504.0 9087.2 923.4 Equity as % Debt (Cr.) Others (Cr.) of total AUM 42576.5 13099.3 38.2 45338.1 11408.0 31.8 46214.7 7812.9 20.8 42691.1 8561.7 15.4 34350.9 2788.4 36.1 25177.7 3543.1 31.9 19050.9 670.9 37.6 16895.1 2624.4 32.7 19948.4 2227.0 14.2 20784.7 1392.1 10.5 15116.2 -39.2 20.9 6427.9 1202.0 44.7 11785.0 1363.9 1.7 11007.9 410.3 4.2 7035.4 1128.3 10.2
HDFC AMC is the largest AMC with high equity proportion of 38%.
We believe as the equity proportion of the AMC is higher at 38%, the valuation assumed at 5% of AUM is conservative for HDFC. If we analyse past deals, IDFC-Standard Chartered AMC, Nomura-LIC AMC and L&TCholamandalam deals were fairly cheap in the range of 1.5-5.7% due to their considerably low equity proportions in total AUM and smaller AUM sizes. The recent Nippon-Reliance AMC deal values the AMC at 6.7% of AUM at 32% equity AUM in total assets of | 82306 crore.
We have valued HDFC AMC at 5% of FY13E AUM
We have assumed a 15% increase in FY13E and FY14E AUM to | 124257 crore. Based on FY13 estimates, we have valued the AMC at 5% of AUM leading to | 21 per share of HDFC.
Exhibit 34: AMC valuation. Still conservative
FY2011 AUM avg Growth (%) Multiple - % of AUM Value at 5% of AUM HDFC's stake at 60% No. of o/s shares Value per share of HDFC 89,482.0 1.6 5.0 4,474.1 2,684.5 146.7 18.3 FY2012E 93,956.1 5.0 5.0 4,697.8 2,818.7 147.4 19.1 FY2013E 108,049.5 15.0 5.0 5,402.5 3,241.5 152.9 21.2 FY2014E 124,256.9 15.0 5.0 6,212.8 3,727.7 152.9 24.4
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PMS also remains a high profit business for AMC and HDFC has | 6300 crore of assets in the same. We can valu the PMS business at 9% of forward AUM of | 7623 crore, however we have not added the same to the valuation of HDFC.
HDFC ERGO General insurance business a while to be profitable

The general insurance industry has been suffering from losses for the last couple of years as de-tariffing impacted pricing and motor pool loss provisions also led to increased losses for the companies. ERGO holds a 26% stake in HDFC General Insurance Co. Industry GWP grew 24% to | 44127 crore in FY11. HDFC ERGOs GWP grew 40% to | 1407 crore. Net retained premium also grew 50% to | 600 crore. On account of motor pool loss provisions, the company made a loss of | 36.4 crore improving from a loss of | 94 crore in FY10.
Exhibit 35: Segment-wise premium underwritten by HDFC-ERGO General Insurance
Miscellaneous 10%
Marine 3% Fire 14% Home 0% Specialty 3% Travel and Health 23%
Motor 38%
Personal Accident 9%
Source: Annual Report, IRDA, ICICIdirect.com Research
HDFC ERGO enjoys a GWP based market share of 3.2% on an overall basis and 7.7% among private players. Private players enjoy 41.7% share in total premium as on 9MFY12. We expect the same to be maintained.
Exhibit 36: Market share of private players in general insurance 9MFY12 GWP basis
Bharti AXA General SBI General Future Generali Shriram General 4% Universal Sompo 2% Cholamandalam 6% HDFC ERGO General 8% Royal Sundaram 7% Tata-AIG 8% Reliance General 8% IFFCO-Tokio 9%
Bajaj Allianz 15%
ICICI-Lombard 23%
Source: IRDA, ICICIdirect.com Research
Page 19
We have valued the general insurance business at 1x FY13E net worth
Exhibit 37: General insurance valuation matrix

FY10 GWP Net Retained premium GWP growth Mkt share in total Combined ratio PAT Networth Valuation HDFC share-74% Multiple on NW No. of o/s shares Value per share of HDFC 1004.6 400.1 2.8 121.0 -94.3 247.9 143.6 FY11 1407.8 606.4 40.1 3.2 99.0 -36.4 423.4 146.7 FY12E 1860.0 837.0 32.1 3.8 94.0 -10.0 471.4 471.4 348.9 1.0 147.4 2.4 FY13E 2046.0 920.7 10.0 3.7 94.0 40.9 512.3 512.3 379.1 1.0 152.9 2.5 FY14E 2250.6 1125.3 10.0 3.6 95.0 45.0 557.4 557.4 412.4 1.0 152.9 2.7
Source: IRDA, Company, Annual Report, ICICIdirect.com Research
We have valued the business at 1x net worth as profits cannot be appropriately estimated. We, thereby, assign | 2.5 per share to HDFCs SOTP valuation.
HDFC Standard Life gaining on bancassuarnce

HDFC Life grew its premium income from | 349 billion in FY01 to | 2,916 billion in FY11, resulting in a CAGR of 24% in the past decade. Post September 2010 new regulations, the Indian life insurance industry had to make several adjustments to its products and distribution methods. The focus for most insurers has shifted towards better expense management, a balanced product mix and higher persistency.
HDFC Standard Life has a market share of 12.9% as on FY11 and ranks among the top 5 private life insurers
New business premium (NBP) slowed down considerably declining 7% in 9MFY12. Also, margins contracted for most players from 20% levels to sub 15%. HDFC Standard Life is among the top 5 private life insurers with a market share of 12.9% in FY11. NBP for HDFC grew 20.7% to | 4059 crore in FY11. In 9MFY12 also, the first year regular premium declined 17% YoY to | 1670 crore. We expect FY12 to end with just 2.6% growth in NBP and forecast around 12-14% growth in the next two years.
Exhibit 38: Industry premium break-up
3000 2600 2200 (| bn) 1800 1400 1000 600 200 489 FY09 FYP 1,345 382 1,553 1,646 492 622
608 FY10 Renewal Premium Single Premium
636 FY11
Page 20
The share of renewal premium has risen to 55% in FY11 from 52% in FY09 for HDFC Standard Life. This should result in better persistency ratios for the company and, hence, future profitability. Till date, HDFC, the parent, has invested | 21 billion in the life business. Its losses have declined to | 99 crore in FY11 from a loss of | 275 crore in FY10 due to increasing share of bancassurance in total distribution.
Life Insurance losses have declined to | 99 crore in FY11 from a loss of | 275 crore in FY10 due to increasing share of bancassurance in total distribution.
Exhibit 39: Rising Bancassurance leading to declining losses

120 100 80 (%) 60 40 20 0 FY07 FY08 Agency FY09 Bancassurance FY10 Direct FY11 54 60 51 2 44 1 39 2 47 2 55 3 66
43
31
Exhibit 40: HDFC premium and APE growth

| Crore NBP Growth (%) Annual premium Single Growth (%) Nonsingle-FYP Growth (%) Regular/ Renewal APE Growth (%) FY08 2679.3 187.5 4852.3 405.1 22.1 2274.2 76.0 2173.0 2314.7 74.6 FY09 2644.0 -1.3 5505.0 311.0 -23.2 2333.0 2.6 2861.0 2364.1 2.1 FY10 3364.1 27.2 7005.0 273.6 -12.0 3090.5 32.5 3640.9 3117.9 31.9 FY11 4059.3 20.7 9004.1 720.3 163.3 3339.1 8.0 4944.8 3411.1 9.4 FY12E 4166.7 2.6 9606.0 727.5 1.0 3439.2 3.0 5439.3 3512.0 3.0 FY13E 4740.8 13.8 10724.0 785.7 8.0 3955.1 15.0 5983.2 4033.7 14.9 FY14E 5317.8 12.2 11899.3 848.5 8.0 4469.3 13.0 6581.5 4554.1 12.9
As on September 30, 2011, the company reported its market consistent embedded value at | 43.5 billion. Also, in 9MFY11, the new business margin (NBAP) on the individual business is pegged at 15.6% (based on loaded acquisition expenses).
We have valued HDFC Standard Life at 14% NBAP margin and 11x multiple + EV basis
We have valued the life business on embedded value (EV) + NBAP basis. EV includes the net worth and value in force (VIF) business. The life business calculated EV comes at | 47.3 billion at end FY12. Hence, at 14% NBAP margin and 11x multiple and adding EV, we have valued the life insurance business at | 10943 crore on FY13E. HDFCs stake at 72.3% comes to | 7922 crore providing | 52 per share of HDFC.
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Exhibit 41: Valuation matrix | Crore

NBAP margins of 13.0 14.0 Valuation multiple of 10.0 12.0 11.0 14.0 EV HDFC share in EV HDFC's share in NBAP - 72.4% Total stake value No. of o/s shares Value per share of HDFC
FY10
405.3 436.5 4053.2 4365.0 4458.5 4801.5 3476.3 143.6 24.2
FY11
443.4 477.6 4434.4 4775.5 4877.8 5253.1 3870.0 2801.9 3803.2 6605.1 146.7 45.0
FY12E
456.6 491.7 4565.6 4916.8 5022.1 5408.4 4350.0 3149.4 3915.7 7065.1 147.4 47.9
FY13E
524.4 564.7 5243.8 5647.1 5768.2 6211.9 4731.0 3425.2 4497.4 7922.6 152.9 51.8
FY14E
592.0 637.6 5920.4 6375.8 6512.4 7013.3 4967.5 3596.5 5077.7 8674.2 152.9 56.7
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HDFC Bank akin to HDFC in consistency and profitability

HDFC Bank which is the second largest private lender in India is the associate of HDFC holding 23.2% stake. HDFC Bank has displayed astounding consistency in its performance over the past 5 years with 35% CAGR in both advances and net profit. The loan portfolio as on Q3FY12 stood at | 194 billion. The bank enjoys one of the highest CASA ratio of ~47% enabling it to maintain NIM at ~4%. We expect HDFC Bank to witness 30% CAGR in net profits over FY11-FY13E. We have valued the bank at 3.9x FY13E ABV of |140/share. With 23.2% stake, HDFCs interest in HDFC Bank is valued at |169/share of HDFC.
Gruh Finance Ltd - a small listed housing finance subsidiary

Gruh Finance Ltd is the 60.4% owned subsidiary of HDFC Ltd. The company was incorporated in 1986 and provides financial services mainly for rural housing, construction/upgradation of dwelling units and to developers. It also offers loans to the self employed segment where formal income proofs are not available. The company has a network of 121 offices mainly concentrated in Gujarat, Maharashtra and Karnataka. It is the second listed subsidiary after HDFC Bank.
Gruh Finance has witnessed a healthy CAGR of 24% in the past five years along with strong return ratios
As on Q3FY12, the companys loan portfolio has increased 28% YoY to | 37.6 billion. Over the past five years, the loan book has witnessed a healthy CAGR of 24%. The market share stands at 0.5% as on FY11. The GNPA as on Q3FY12 stood at 0.97% while the NNPA was nil. Net profit has witnessed growth at a CAGR of 25% over FY06-11 to | 0.9 billion. As on 9MFY12, the net profit stood at | 65 crore. We expect 20% growth in net profit for FY13E to | 104 crore and estimate net worth of | 4.3 billion as on FY13. With HDFCs holding at 60.4%, we assign a value of | 10 per share to HDFCs SOTP valuation.
Exhibit 42: Rising return ratios for Gruh Finance
35 30 25 (%) 20 15 10 FY07 FY08 FY09 RoE RoA FY10 FY11 23.6 2.2 23.9 2.5 24.5 2.7 2.3 28.4 3.1 31.4 3.5 3.0 2.5 2.0 1.5 1.0 (%)
Source: Company, Capitaline, ICICIdirect.com Research
Page 23
Analysing equity investment book and unrealised gains.
HDFC has a quoted equity book of | 61 billion and unquoted equity of | 27 billion as on FY11. Of the above, | 56 billion from the former and | 23 billion from the latter relates to investments in subsidiaries and associates. Hence, this leaves only | 4.9 billion in quoted and | 4.45 billion in unquoted equity, which relates to external investments made by HDFC.
We have assigned | 4 per share to SOTP valuation for unrealised gains of | 6 billion on quoted equity book (after excluding investments relating to subsidiaries and associates)
As we have taken HDFC Bank and Gruh Finances valuations separately based on market prices in the SOTP target, we have assigned only the balance investments for unrealised gains in the quoted book. This has resulted in unrealised gains of just | 6 billion translating to | 4 per share of HDFC. We have ignored unrealised gains on the unquoted equity book.
Foray into education sector- still at nascent stage

Last year, HDFC announced its strategic foray into the Indian education sector under which it intends to provide access to quality yet affordable education spread across nearly every segment over the students learning life cycle. Such a foray is still in its early stage. Invested in Credila Financial Services, first Indian education loan company Credila is a 62.3% subsidiary of HDFC and is Indias first and only fully dedicated educational loan company, providing loans to undergraduate and postgraduate students studying in India and abroad. As on FY11, Credila had disbursed | 190 crore. The average loan amount disbursed is | 7 lakh. Credila capitalises on HDFCs distribution network to source and market education loans. For FY11, it had a loss of | 11.3 crore.
We have not factored HDFCs interest in the education space in our forecasts and valuations considering these businesses are still at their nascent stages.
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Risks and concerns

Any major change in management
One of the key reasons for HDFCs consistent performance has been the role of its experienced and strong management. Any major change in the composition of the management and board may result in uncertainty about the future business strategy and performance.
Rise in competition
As stated above, the housing finance industry in India is very competitive with 53 registered HFCs and various SCBs. Any rise in competition, mainly from SCBs as witnessed in FY09 wherein they became very aggressive in terms of pricing by introducing teaser loans, may result in HDFC losing market share. This, in turn, could lead to lower loan growth than our estimates.
Sustainable economic slowdown may impact business growth

Another risk to our estimates could be a sustainable slowdown in the economy, which could affect the growth of the housing finance industry adversely. Apart from affecting growth, a slowdown in the economy could also affect the re-payment ability of borrowers. This could lead to a higher-than-expected increase in delinquencies for the company.
Exhibit 43: Housing loans industry growth follows GDP growth
35 30 25 (%) 20 15 10 5 0 FY06 FY07 India GDP Growth YoY FY08 FY09 FY10 9.4 9.6 5.8 30.3 27.6
16.9
17.1 7.4
17.3 8.3
Housing Finance Industry Growth YoY
Source: Bloomberg, ICICIdirect.com Research
Risk to margins
Any further increase in the cost of funding and the inability to pass on such hikes to customers may result into lower margins than expected.
Moderation in performance of subsidiaries owing to stringent regulations

Any stringent regulations in relation to HDFCs key subsidiaries (HDFC Standard Life) as we saw in the general insurance and asset management business and a sustainable slowdown in the economy could impact their business and earnings growth. This could adversely affect HDFCs valuations.
Page 25
NHB regulations may impact profitability

In the last 15-16 months, National Housing Bank (NHB) came out with various amendments. This was related to the loan-to-value (LTV) ratio, risk weights and provisioning requirements in relation to housing as well as non-housing loans and scrapping of pre-payment penalty on preclosure of housing loans on a floating rate basis and also on fixed rate bases subject to certain conditions. However, such amendments did not affect HDFC much as the company was well within the requirement. NHB in October, 2011 came out with a circular asking HFCs to charge uniform rates of interest to old and new borrowers in the floating loan portfolio with the same credit/risk profile. In February, 2012 NHB cleared that HFCs should apply uniform rates of interest to all individual borrowers with the same credit/risk profile and who have availed housing loans on a floating rate basis after the date of the Circular in October, 2011. As regards the existing customers of HFCs as on the date of Circular dated October 19, 2011, NHB has stated that the matter is under examination.
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Financials
Net interest income (NII) to rise at 24.5% CAGR in FY12-14E
Over the past five years, HDFCs NII has witnessed a strong CAGR of 27% on account of healthy growth at 21% CAGR in loans outstanding and stable spreads or NIM. Going forward, we expect HDFCs NII to witness a CAGR of 24.5% to | 77 billion over FY12-14E led by 20% CAGR in loans over the next two years. Further, we believe that interest rates have peaked and large wholesale borrowing by housing finance firms allows them to adjust price faster giving them a competitive advantage against banks as rates decline. Since HDFC is more than 75% wholesale funded, a declining interest rate environment augurs well for the company. We believe that HDFCs healthy NIM of ~3.8- 4% would be sustainable, going forward.
We expect NII to witness a CAGR of 24.5% over FY12-14E supported by healthy growth at 20% CAGR in loans and stable margins
Exhibit 44: NII to grow consistently with NIM maintained

90 80 70 60 50 40 30 20 10 0 77 63 52 42 27 13 16 26 31 16 34 25 11 FY10 FY11 FY12E FY13E FY14E 22 22 70 60 50 (%) 40 30 21 20 10 0 FY06 FY07 FY08 FY09 NII
61 46
(| bn)
NII Growth YoY (RHS)
Non interest income to grow moderately

HDFCs non-interest income increased at a healthy CAGR of 37% in the past 3 years to | 10.7 billion as on FY11. Excluding profit on sale of investments also, core non-interest income increased at 37% CAGR. Major component of non interest income are dividends amounting to | 2.5 billion, income from deployment in cash management schemes of mutual funds of | 2.6 billion and profit on sale of investments of | 1.9 billion (down 16% YoY) as on 9MFY12. For 9MFY12 total non-interest income grew 29% YoY to | 9.3 billion. Non interest income forms 18% of net total income. We estimate non-interest income excluding profit on sale of investments to expand at moderate rate of 9% CAGR over FY1214E.
Exhibit 45: Profit on sale of investments declined 15.5% YoY
| billion Dividend Income Fees & other charges Income from leasing Misc. income Profit on sale of investments Surplus from deployment in CMS of MFs Total FY09 FY10 FY11 9MFY12 9MFY11 2.0 1.1 0.2 0.2 0.2 1.6 5.3 2.3 2.3 0.2 0.2 2.1 1.9 9.1 2.3 2.2 0.2 0.3 3.6 2.2 10.7 2.5 2.1 0.1 0.2 1.9 2.6 9.3 1.7 1.4 0.2 0.1 2.3 1.5 7.2 YoY Growth (% )* 47.9 46.9 -58.9 4.1 -15.5 72.3 29.1
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PAT to grow at 19% CAGR during FY12-14E driven by healthy business fundamentals and improvement in leverage
Profit growth to continue to be sanguine

We expect a healthy CAGR of 19% to | 59 billion in profit for HDFC over the next two years on the back of 24.5% CAGR in NII and healthy operating efficiency. Profits have witnessed a strong CAGR of 23% in the past five years. For 9MFY12, the net profit grew by 17% y-o-y to | 27.9 billion. We expect credit cost to remain largely stable, which will further enhance the profitability. HDFCs provisioning expenses have always been comfortably higher than regulatory requirements. Provisions for contingencies as on FY11 were | 11.2 billion, which was 1.4x the regulatory requirement. We have not factored in the write-back of provisions on teaser loans, expected to be around | 300 crore which can enhance profitability. However, increase in NIMs or spreads in relation to teaser loan portfolio getting reset to current floating rates (up by 150-200 bps) in Q1FY13 is factored in our estimates.
Exhibit 46: Trends in profitability growth remain robust
70 60 50 (| bn) 40 30 20 10 0 FY06 FY07 FY08 13 21 16 -6 FY09 PAT FY10 FY11 FY12E FY13E FY14E 35 25 24 23 28 24 25 17 55 49 41 19 59 60 50 40 (%) 30 19 20 10 0 -10
PAT Growth YoY (RHS)
Comfortable capital adequacy ratio

HDFC has a comfortable capital adequacy ratio of 13.9% with Tier I capital at 12.2% as on Q3FY12, which is above the regulatory requirement of 12% for HFCs. For FY13E, we have factored in a conversion of warrants expected in August 2012 at | 600 per share, which would lead to ~3.5% dilution.
Exhibit 47: Trends in capital adequacy ratio
18 16 14 12 10 8 6 4 2 0 16.8 15.1 14.6 14.6 14.04 12.8 13.9
HDFC warrants due for conversion by August 2012 is currently trading at | 77 and gives the right to buy one HDFC share at | 600.
13.2
(%)
12.23
7.6
FY08
FY09
FY10 CAR Tier I
FY11
9MFY12
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Healthy returns ratios

We expect return ratios to remain healthy at 22.8% RoE and 2.8% RoA for FY13E
HDFC has reported excellent return ratios in the past as compared to peers on the back of consistent and healthy growth in loans, impeccable margins, improving asset quality and stellar operating efficiency. We believe HDFCs strong fundamental parameters will remain intact going forward and, hence, expect healthy RoE of 22.8% and RoA of 2.8% for FY13E.
Exhibit 49: Higher returns ratios as compared to banks (FY11)
Exhibit 48: Healthy returns ratios - HDFC

24.0 22.0 20.0 18.0 16.0 14.0 12.0 10.0 21.7 20.0 18.2 2.5 2.6 2.8 2.8 2.8 2.9 22.9 22.8 22.8 3.1 2.9 2.7 2.5 2.3 2.1 1.9 1.7 1.5
30.0 25.0 20.0 21.7
25.8 21.9 12.6 2.8 HDFC 2.1 LICHF RoE 2.0 DEWH RoA
(%)
(%)
(%)
15.0 10.0 5.0 0.0
0.7 SBIN
FY09
FY10
FY11 RoA
FY12E
FY13E RoE
FY14E
Page 29
Valuations
On the back of its strong brand equity, stable and experienced management, consistent track record in earnings and business growth, stable asset quality and attractive return ratios, HDFC has commanded premium valuations over the years. We believe that with the housing finance market still under-penetrated, long term visible and sustainable growth potential exists for HDFC. Its market leadership with over 17% share should be expected to remain stable. We expect earnings to grow at 19% CAGR over FY12-14E on the back of a healthy increase in loans, stable spreads (calculated 2.9%), solid asset quality (factored in conservative credit cost of 0.13% in FY13) and best in class operating efficiency. We expect RoE of 22.8% and RoA of 2.8% for FY13E. Currently, the investments (mainly subsidiaries and associates) contribute 28% to consolidated profit but the management expects the share to go up significantly in the next five years and also provide opportunities for value unlocking. At the CMP of | 667, the stock is trading at 21x FY13E Standalone EPS and 4.2x P/BV of its FY13E adjusted book value (ABV). Excluding the valuation of subsidiaries and associates of ~| 230 per share of HDFC based on FY12E, the standalone housing finance business is trading at 3.6x FY12E core ABV. We have valued the standalone lending business at 3.1x FY13E core ABV and14.8x FY13E core EPS giving | 464 per share of HDFC.
Exhibit 50: Core business RoE and ABV
(Year-end March) FY09 17.1 87.8 FY10 19.1 97.0 FY11 20.9 109.9 FY12E 22.8 119.6 FY13E 21.0 149.8 FY14E 22.6 165.6
Core RoE (%) Core Mortgage ABV

We have valued HDFC on an SOTP basis and arrived at a target price of | 719/share.
Valuing the subsidiaries post 10% discount at | 255 per share for FY13E, We have arrived at an SOTP target price of | 719 per share. We are initiating coverage on the stock with a HOLD rating.
Exhibit 51: SOTP valuation table

Value of HDFC's stake (%) stake (| bn) 100 23.2 60 72.4 74 60.4 100 710 295 32 79 4 16 6 Valuation post discount (| bn) 710 266 29 71 3 14 6 FY13E Value per share 464.4 173.8 19.1 46.6 2.2 9.2 4.0 719
Company HDFC Ltd HDFC Bank HDFC AMC HDFC Std. Life HDFC ERGO GRUH Finance Unrealised Gains
Basis of valuation 3.1x FY13E Core Mortgage ABV 3.9x FY13E ABV 5% of MF AUM EV + NBAP 1x FY13E NW 6x FY13E NW On quoted equity book excl. subsidiaries/ associates Value Per Share of HDFC Ltd (|)
% Discount 0 10 10 10 10 10 0
Page 30
Exhibit 52: Peer comparison - Valuations

CMP (|) HDFC LIC Housing Fin. Dewan Housing Fin. SBI 667 261 231 2130 M.Cap (| cr) FY11 98513 13169 2703 135242 27.7 12.7 10.1 16.4 PE (x) FY12E 23.7 13.3 7.7 13.6 FY13E 20.7 10.3 5.7 10.4 FY11 5.7 3.0 1.6 2.4 P/BV (x) FY12E 5.3 2.3 1.3 2.1 FY13E 4.2 2.0 1.1 1.8
Source: Company, Bloomberg, ICICIdirect.com Research
HDFC has outperformed Sensex in returns and has traded at a premium of 25-35% to Sensex even post crisis.
Exhibit 53: HDFC Premium/Discount to Sensex PE

80 70 60 50 40 (%) 30 20 10 0 Nov-07 Oct-10 Aug-06 -10 -20 May-10 Aug-11
13500 12000 10500 9000 7500
Jan-07
Jul-09
Dec-09
Mar-06
Current premium
Avgerage 5-yr premium
Exhibit 54: HDFC share price vs. BSE Bankex

900 750 600 450 300 150
Aug-11
Nov-11
Oct-11
Jun-11
Jan-12
Feb-11
Dec-11
Feb-12
Apr-11
Mar-11
Sep-08
Jun-07
Feb-09
Apr-08
Mar-11
May-11
HDFC Ltd (LHS)
BSE Bankex (RHS)
Source: Bloomberg, ICICIdirect.com Research
Page 31
Mar-12
Jul-11
Sep-11

(|) 1000 200 400 600 800 Price (|)

5.5x 5x 4.5x 4x 3.5x
Exhibit 55: One year forward P/ABV band
Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12
Page 32
Financial Scorecard (Standalone)

Exhibit 56: Profit and Loss
| Crore (Year-end March) Interest Earned Interest Expended Net Interest Income % growth Non Interest Income Net Income Employee cost Other operating Exp. Operating Income Provisions PBT Taxes Net Profit % growth EPS (|) FY10 10450.6 7063.1 3387.5 10.9 910.2 4297.8 146.7 177.1 3974.0 58.0 3916.0 1089.5 2826.5 23.8 19.7 FY11 11807.0 7559.9 4,247.1 25.4 1071.1 5,318.1 175.5 205.6 4937.0 70.0 4867.0 1332.0 3,535.0 25.1 24.1 FY12E 14704.6 9507.7 5,196.9 22.4 1130.4 6,327.3 208.5 242.1 5876.7 163.1 5713.7 1565.5 4,148.1 17.3 28.1 FY13E 17186.0 10848.1 6337.9 22.0 1190.1 7528.1 254.8 280.3 6993.0 194.3 6798.7 1862.8 4935.9 19.0 32.3 FY14E 20198.7 12517.8 7680.9 21.2 1244.1 8924.9 301.4 326.1 8297.5 233.5 8064.0 2209.5 5854.5 18.6 38.3
Exhibit 57: Balance sheet

(Year-end March) Sources of Funds Capital Reserves and Surplus Networth Secured Loans Unsecured Loans Other Liabilities & Provisions Total Applications of Funds Fixed Assets Investments Advances Other Assets Total 222.1 10727.4 97967.0 7439.2 116355.7 234.0 11832.4 117126.6 9861.0 139054.0 551.2 12204.1 139373.0 7739.3 159867.6 557.4 12886.8 166051.0 8596.6 188091.9 287.1 14910.6 15197.7 63605.7 32959.7 4878.5 116641.4 293.4 17023.1 17316.5 81641.5 33769.0 6775.1 139502.1 294.8 18666.2 18961.0 95972.5 38869.6 6064.5 159867.6 305.8 24033.4 24339.2 112181.1 44887.6 6684.1 188091.9 FY10 FY11 FY12E FY13E
| Crore FY14E 305.8 26648.9 26954.6 130888.5 54064.8 7392.4 219300.3
567.0 13079.4 199539.7 6114.3 219300.3
Page 33
Exhibit 58: Key ratios

(Year-end March) Valuation No. of Equity Shares EPS (Rs.) BV (Rs.) BV-ADJ (Rs.) P/E P/BV P/adj.BV Yields & Margins Yield on interest earning assets Avg. cost on funds Net Interest Margins Spreads Adjusted spreads * Quality and Efficiency Cost / Total net income GNPA% NNPA% RONW (%) ROA (%) 10.8 7.8 3.5 3.0 2.6 7.5 0.8 0.1 20.0 2.6 10.6 7.1 3.8 3.5 2.8 7.2 0.8 0.0 21.7 2.8 11.2 7.6 3.9 3.6 2.8 7.1 0.8 0.0 22.9 2.8 11.0 7.4 4.1 3.6 2.9 7.1 0.9 0.0 22.8 2.8 10.8 7.3 4.1 3.5 3.0 7.0 0.9 0.1 22.8 2.9 FY10 143.6 19.7 105.9 105.0 33.9 6.3 6.4 FY11 146.7 24.1 118.0 118.0 27.7 5.7 5.7 FY12E 147.4 28.1 126.2 126.2 23.7 5.3 5.3 FY13E 152.9 32.3 157.3 157.1 20.7 4.2 4.2 FY14E 152.9 38.3 174.8 173.2 17.4 3.8 3.9
Source: Company, ICICIdirect.com Research, * Adjusted Spreads is after deducting redemption premium on ZCBs and interest earned on Loans sold.
Exhibit 59: Growth ratios

(Year-end March) Total assets Advances Secured Loans Total Income Net interest income Operating expenses Operating profit (excl trading) Net profit Book value EPS FY10 14.7 15.0 15.3 3.1 10.9 2.4 16.1 23.8 15.7 22.7 FY11 19.6 19.6 28.4 13.4 25.4 17.7 21.6 25.1 13.9 22.4 FY12E 14.9 19.0 17.6 23.0 22.4 18.2 28.4 17.3 7.4 16.8 FY13E 17.6 19.1 16.9 16.0 22.0 18.8 27.2 19.0 29.3 14.7 FY14E 16.5 20.2 16.7 16.7 21.2 17.3 25.5 18.6 11.1 18.6
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RATING RATIONALE
ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: > 10%/ 15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No. 7, MIDC, Andheri (East) Mumbai 400 093 research@icicidirect.com ANALYST CERTIFICATION
We /I, Kajal Gandhi CA, Vasant Lohiya CA, Jaymin Trivedi MBA-CM research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.
Disclosures:
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The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities. While we would endeavour to update the information herein on reasonable basis, ICICI Securities, its subsidiaries and associated companies, their directors and employees (ICICI Securities and affiliates) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securities from doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securities policies, in circumstances where ICICI Securities is acting in an advisory capacity to this company, or in certain other circumstances. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. The value and return of investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to see Risk Disclosure Document to understand the risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to change without notice. ICICI Securities and its affiliates might have managed or co-managed a public offering for the subject company in the preceding twelve months. ICICI Securities and affiliates might have received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. It is confirmed that We /I, Kajal Gandhi CA Vasant Lohiya CA Jaymin Trivedi MBA-CM research analysts and the authors of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Our research professionals are paid in part based on the profitability of ICICI Securities, which include earnings from Investment Banking and other business. ICICI Securities or its subsidiaries collectively do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. It is confirmed that We /I/I, Kajal Gandhi CA Vasant Lohiya CA Jaymin Trivedi MBA-CM research analysts and the authors of this report or any of their family members does not serve as an officer, director or advisory board member of the companies mentioned in the report. ICICI Securities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. ICICI Securities and affiliates may act upon or make use of information contained in the report prior to the publication thereof. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject ICICI Securities and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.
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HDFC LTD (HDFC) : Never Out of Gear

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Initiating Coverage

March 28, 2012

HDFC Ltd (HDFC)

YoY Growth (%)

Indias under-penetrated market to offer long-term growth visibility

Volatility in spreads contained

Comparable return matrix (%)

Seasoned loan portfolio, nil NNPA

Well established subsidiaries to add to future profit & valuation

ICICI Securities Ltd | Retail Equity Research

FII & DII holding trend (%)

Source: Company, ICICIdirect.com Research , *As on Mar 02,2012

Q4FY12* Shareholding pattern (%)

*As on March 02, 2012

Exhibit 2: HDFCs subsidiaries and associates

HDFC Bank 23.2%

HDFC Standard Life 72.4%

HDFC Asset Management 60%

HDFC ERGO General 74%

GRUH Finance 60.4%

HDFC Property Venture 100%

HDFC Venture Capital 80.5%

Credila Financial Services 62.3%

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research

Exhibit 3: HDFC core business model (data as on Q3FY12)

53% 27% 19%

29% 46% 14% 11%

Source: Company, ICICIdirect.com Research

Strong and experienced management

Exhibit 4: Management team

Vice Chairman & CEO

Renu Sud Karnad

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research

Exhibit 6: Trends in Indias mortgage as a percentage of GDP

0 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Mortgage as a % of GDP(Nominal) of India

Source: Company Presentation, ICICIdirect.com Research

Source: Company, CSO, ICICIdirect.com Research

Size and market share dynamics of housing finance industry in India

Exhibit 8: ...while disbursements witness 14% CAGR over FY06-11

Loan Growth (RHS)

Disbursements Growth (RHS)

Source: CRISIL Research, ICICIdirect.com Research

Source: CRISIL Research, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research

13.1 LIC Housing Finance Dewan Housing Finance

ICICI Home finance

Source: Company, ICICIdirect.com Research

Exhibit 10: Trends in HFCs and SCBs disbursements market share

Source: CRISIL Research, ICICIdirect.com Research

Major structural drivers of housing finance industry in India remain intact...

ICICI Securities Ltd | Retail Equity Research

Exhibit 11: Demographic profile as on FY11

Exhibit 12: Demographic profile as on FY16E

Source: Ministry of Home Affairs, ICICIdirect.com Research

Source: Ministry of Home Affairs, ICICIdirect.com Research