Recommendation: Buy
CMP = Rs 2,700
Price target: Rs 3,362
Key points:
- Subsidiaries hold significant value: HDFC has created significant value in its subsidiaries. Three of these — HDFC Bank, HDFC Life Insurance and HDFC Mutual Fund—are valued at Rs883 per share. These subsidiaries are growing faster than HDFC, the value contributed by them would be significantly higher going forward.
- Gaining market share, CRR hikes also helping the cause: HDFC has gained significant market share in the past couple of quarters. Also, continuous CRR hikes by the RBI have benefited HDFC the most, as banks are unable to bring down their lending rates to protect their margins. HDFC doesn't need to maintain CRR, hence its incremental spreads have widened as incremental borrowing costs have declined while lending rates have remained stable.
- Strong earnings visibility: Its core mortgage business is expected to grow at 25-30% over the next couple of years. In Q2FY2008, HDFC's margins expanded and the core operating performance was very strong (up 56% yoy). I expect the earnings before exceptionals to grow at 26% CAGR over FY2007-10E.
- Excellent asset quality despite strong asset growth: Despite the strong business growth the net NPA is almost negligible and the gross NPA is below 1%. Strong credit appraisal and risk monitoring techniques have helped HDFC to maintain a very healthy asset quality.
- Valuations look attractive: I have valued the core mortgage business at 22x FY2010E EPS and if we adjust Rs 954 for the value assigned by us to its subsidiaries from the CMP of Rs 2,700, HDFC is quoting at 15.9x its FY2010E earnings and 3x FY2010E book value. I feel the valuations look attractive considering HDFC's consistent above 20% earnings growth record, the potential value unlocking from its various subsidiaries and investments, and the superior track record of its management.
- I recommend a Buy call on the stock with a 12-month price target of Rs 3,362.
