HDFC valuations indicate upside for stock: Listing of biz units is positive

Capital raising, listing of business units are positives

While investor sentiment is down on public sector banks (PSBs) and some private corporate lenders, there are others which are expected to continue creating value for its shareholders. Housing Development Finance Corporation (HDFC) is one such.
 
The HDFC stock has gained about 30 per cent over the past year as compared to PSBs on the Nifty, down 13.5 per cent; private corporate lenders have gained 15.3 per cent. After reporting a strong set of numbers in October-December 2017 (Q3, see table), a sum-of-the-parts (SOTP) valuation of the company looks attractive.
 
SOTP valuations take into account those of all other business units or subsidiaries or associates of a parent company, in proportion to the stake. Apart from positive business potential, recent developments make the case stronger for a higher valuation of the consolidated entity.
 
First, the company raised equity capital of around Rs 130 billion, through QIP (qualified institutional placement) and preferential allotment, in the January-March 2018 quarter, expanding the book value. Though it will marginally drag down the return on equity (RoE), it will boost the valuation. Banks and financial corporations are mostly valued on the basis of their book value and a rise in this indicates higher potential in the share price.
 

Asutosh Misra, analyst at Reliance Securities, had indicated a 29 per cent increase in HDFC's book value with the latest capital raising. The benefits of the latter programme will also accrue to HDFC Bank, as HDFC intends to participate in the preferential issue of its banking subsidiary. The incremental investment in HDFC Bank will also push up HDFC’s valuations. The share of HDFC Bank in the SOTP valuations of HDFC is about 28 per cent.
 
The second valuation trigger is the Initial Public Offer of equity (IPO) at HDFC Asset Management Company (HDFC AMC), which is a subsidiary, though the contribution to the SOTP is lower. After listing on the bourses, the valuations (enterprise value) of HDFC AMC and in turn that of HDFC are expected to go up.
 
“Listing of HDFC AMC definitely will have a positive impact on HDFC's valuations. Generally, enterprise valuations of subsidiaries or associates (HDFC AMC in this case) increase post listing due to enhanced levels of disclosure, along with market-based price discovery,” says Misra. HDFC AMC's valuations are expected at around Rs 300 billion.
 
HDFC's general insurance arm is also expected to go for an IPO, giving an upward thrust for the parent company's valuation.
 

Also, the company's long-term prospects in terms of credit and earnings growth remain strong. Low penetration of mortgages, increased urbanisation and the government's affordable housing programme are likely to augur well. While advances are likely to surge by 17.5 per cent in FY19, its net interest income and net profit (adjusted for one-time income on account of profit on sale of investments in HDFC Life) are expected to rise by at least 20 per cent each.
 
Given the positive outlook on the valuation and overall business, investors could consider HDFC for a long-term investment horizon, with many brokerages being bullish on the stock.