When Keki Mistry, the Vice Chairman and CEO of HDFC, was asked why the company stock had not performed to its potential, he said it was due to the uncertainties in the global environment. "Be it the strengthening of the dollar or events related to the US economy, Europe or Brexit, whenever there is global uncertainty, which may not have anything to do with HDFC or with India, there is a flight to safety, wherein investors pull out money from emerging markets and invest in the US," he says. In the past one year, holdings of foreign institutional investors in HDFC have come down from 78.17 per cent on September 30, 2015 to 77.27 per cent on September 30, 2016.
However, between October 1, 2015 and September 30, 2016, the average market capitalisation (m-cap) of India's largest housing finance company witnessed a rise of 1.4 per cent from Rs 1.91 lakh crore to Rs 1.94 lakh crore. Despite the good showing, it has underperformed its peers. Says Mistry: "There are many factors for markets to go up or down, but they have nothing much to do with our core business. What we have to do is to focus on our business. Our goals and strategy are very clear - to derive higher and higher return on equity, which in turn will bring in long-term investors."
While the company's average market cap recorded a small gain, it outperformed the BSE Sensex, which on a one-year average, ended September 30, 2016, reported a fall of 6 per cent. The gain in the stock helped HDFC jump three places to number seven compared to number 10 in Business Today's market capitalisation pecking order last year.
SIZE THE BIGGEST CHALLENGE
The primary reason for the underperformance when compared to its peers has been the slowdown in growth. "While HDFC is one of the best bets among housing finance companies that have been very focused on return of equity and quality of profit, its size has been the biggest challenge for HDFC," says Nidhesh Jain, Research Analyst at Investec. Mistry concedes: "The challenge is to maintain a base that is getting larger and larger. Even if we grow at 20 per cent as compared to a newer player who grows at 50 per cent, people will say we are growing at a slower pace. But the fact is the assets that we would pick-up in a fortnight, the new player would take at least one year to grow to that size." HDFC has been consistently improving its ROE, which is close to 22 per cent as on 2015/16.
ADDING VALUE TO SHAREHOLDERS' WEALTH
"We focus on efficiency. We have told investors that we will not just only focus on top line growth. Our priority is on ROE, asset quality, operating efficiency and growth, that too measured growth," says Mistry. "It is easy to generate accounting profits. If you are short-sighted, you can grow faster to generate higher accounting profits, but that's not a long-term strategy."
HDFC measures its success on the expense-to-asset ratio and cost-to-income ratio. The company's cost-to-income ratio of 7.6 per cent, in fact, is the lowest in the financial sector, globally. Mistry feels the company is being able to drive efficiency by cutting down operating costs, which gives it huge leverage from a profitability perspective. The cost-to-income ratio has improved from 13.8 per cent in 1999/2000 to 7.6 per cent in 2015/16.
"To HDFC's credit, the company has been quick to rebalance its business mix when the real estate sector came under stress. While others focused on growth, HDFC focused on safety," says Jain of Investec. "It was a conscious decision to bring down their corporate loan portfolio. With the investment cycle being poor, its non-individual business, which was about 33 per cent four years ago, has come down to 27 per cent in the June 2016 quarter." The change could also be due to the rising non-performing loans in the non-individual portfolio, which was at 1.11 per cent as on June 2016, compared to 0.6 per cent in individual loan portfolio during the same period. "While margins are higher in non-individual loans, it also carries a higher risk in case of defaults. With the corporate loan book slowing, margins have come under pressure for HDFC. But focus on safety augurs well for it as once the tide settles down, HDFC will come out as a clear winner," adds Jain.
"My sense is that the private sector investment cycle in India is going to take off very soon. When it does, more buoyancy will come into the system. And then, anything to do with retail credit will move. So, for the next two to three years, we see huge growth in every one of the businesses - be it asset management or life insurance, general insurance or the housing finance business," says Mistry.
He is betting on the huge market potential purely because of low penetration in India for each of its businesses. "Housing loan outstanding across banks and financial institutions is 9 per cent of India's GDP, compared to 60-70 per cent globally. Even compared to emerging markets, barring Brazil, it would be 17-25 per cent. Second, the average age of a home buyer in India is 37 years at a time when two-thirds of the population in India is below 35. Therefore, we see huge potential in our core business," says Mistry.
In August, HDFC also unlocked the value in its life insurance business through a merger with Max Life. "Now, its value is Rs 60,000 crore-65,000 crore, compared to around Rs 15,000 crore, given by sell-side analysts earlier," says Mistry, adding: "In the next five years, we will unlock value in subsidiaries, including the education and asset management businesses, but our core business will do well for several years to come, given the strong macro environment."
Raising funds for growth has never been an issue for HDFC as it has always managed to borrow at low rates. Now that some of its subsidiary businesses have also started generating cash, any revival in the investment climate will only help the company scale higher. ~
@MaheshNayak