HDFC: Value unlocking triggers ahead

The forthcoming IPO of HDFC Standard Life will lead to higher value unlocking for the company

The coming initial public offering (IPO) of equity in HDFC’s life insurance subsidiary, HDFC Standard Life, will lead to higher value unlocking for the company.

While recent stake sales (Standard Life, Azim Premji) value HDFC Standard Life at about Rs 20,000 crore, the management believes this could increase. So do analysts. “By the time the IPO hits the market, which is another six months, the valuations would have gone up by another 10 per cent, as targeted by the HDFC management. At Rs 20-23,000 crore, the company appears fairly priced at over two times the price/embedded value,” says Suresh Ganapathy, analyst, Macquarie Capital.

Higher valuations will give a leg-up to the sum-of-the-parts valuations. Vaibhav Agrawal, banking analyst at Angel Broking, says, “We value HDFC's subsidiaries, excluding HDFC Bank, at Rs 125 a share. However, if the IPO happens at higher valuations, this number could go up by 10-15 per cent.” He has a target price of Rs 1,105.

Most of HDFC's subsidiaries are growing at a healthy pace and are profitable. Its general insurance subsidiary, HDFC Ergo General Insurance, saw sale of additional stake to Ergo at a higher valuations of Rs 4,900 crore. The profit on this stake sale is likely to reflect in HDFC's FY17 results. While analysts believe this business could also get listed, this is some time away.

The assets management business has been growing at a healthy clip. Its affordable housing subsidiary, Gruh Finance, is the highest valued financials stock in India and continues to post strong growth in earnings and revenue. Increased focus on affordable housing and under-penetration of organised players are key factors for Gruh Finance's strong performance.

While HDFC Bank's earnings growth has moderated in recent quarters, this is in sync with sectoral trends. The bank is relatively more resilient to asset quality shocks and, hence, is considered a defensive investment by most analysts.

For the March quarter, HDFC's earnings will be aided by a one-time profit of Rs 1,220 crore from a nine per cent stake sale to Standard Life in August last year. Notably, this gain will account for more than half of HDFC's net profit in the quarter. Consensus Bloomberg expectations peg HDFC's standalone net profit in the quarter at Rs 2,266 crore. Excluding the stake sale gains, earnings growth will be muted. Though asset quality trends have been healthy so far, investors will watch closely for any potential pressure in its developer loans. The company will make additional provisioning of Rs 450 crore this quarter as a precautionary step for any stress in asset quality.

Owing to the above news flow, the HDFC scrip has been under pressure in recent times and currently trades at about 3.5 times the FY17 estimated book value. Given the company's strong record, healthy prospects and all-round growth of different businesses, most analysts remain positive.

Their average target price of Rs 1,384 a share indicates an upside of 21 per cent from current levels.