October 21, 2002
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HDFC: A problem of plentyVikram Srivastava
Besides, the company also announced the launch of its general insurance business. Considering that the company is upbeat on its insurance business and the quarterly results were also healthy, there was sanguinity in the air. But is that enough for the shareholders? May be not. Because the company has been losing market share to the new players and is also facing a problem of surplus capital with limited profitable avenues to reward its shareholders. The management decided to buy back 5 per cent of the paid-up capital contingent upon the waiver of the condition that the debt-equity ratio of HDFC should not exceed 2:1. As has been the trend in the past, the bonus issue is likely give rise to capital gains for investors, post issue. This is because, technically, the book value of the share is halved after a 1:1 bonus and hence the market price should also follow the same pattern. Yet, bonus issues by growth companies are taken as a bullish signal and hence the share price tends to settle at more than half of the pre-issue value. In other words, it is highly probable that post bonus, the combined value of the shares would be more than the value of the share that was originally held by the investor. The company has also decided to go for a buyback of shares to the maximum limit of 5 per cent. This would be subject to approval by regulatory authorities because the debt-equity ratio of HDFC exceeds the permissible limit of 2:1 for companies post buyback. The logic behind it is that the company wants to reward its shareholders with the surplus capital that it has. The surplus capital has been generated because of the government's decision to further reduce the risk weightage of home loans to 50 per cent. It had earlier cut the risk weightage from 100 to 75 per cent. This would enhance of the capital adequacy ratio of the company from 13.9 per cent to over 16 per cent. Keki Mistry, managing director, HDFC, said the company wanted to reward its shareholders and since it was constrained by law on the amount of dividend that it can pay, it was going in for a buyback.
The proposal for buyback is interesting because it implies that the company has surplus that it has not been able to invest profitably. This is despite the fact that approvals and disbursals of individual loans have grown by 37 per cent this year. Competition is obviously worrisome. HDFC has been losing out on market share to the newer and more aggressive players. Big banks such as the State Bank of India have gained good market share by offering low-priced deals. A pointer to this is the decline in HDFC's spoils from 57 per cent in 1998 to 52 per cent in 2001 and to 48 per cent in 2002. On the other hand, SBI and ICICI have increased their market share to 13 per cent and 10 per cent, respectively. However, some analysts said HDFC is justified in not aggressively targeting market share alone as it may lead to a poor asset allocation, which may produce returns in the short term, but may lead to losses in the future. Therefore, though the company may be able to retain its market share by increasing disbursals, it is doing well not to take on any extra risk. It is argued that HDFC loses out to banks because banks have a better cost structure, thanks to their cheap deposits. However, some of this may just get corrected soon. In recent times, HDFC has been raising money through the debt mart at rates comparable with those paid by banks. Recently, it raised Rs 150 crore (Rs 1.50 billion) for five years at 7.05 per cent. This is comparable to the cost of deposit of the best banks in the country. HDFC has also been raising money overseas at low costs. Thus, while the company might have an overall cost of funds of 10 per cent, the incremental cost of its funds is approximately 7 per cent. In comparison, SBI, which is its biggest threat today, boasts of a cost of deposit of around 6.6 per cent. So, should one buy the stock or sell it at the prevailing price? The factors that determine this are the financial performance of HDFC, its performance versus peers and the plans that it has for the future. As has been discussed, the housing bank has been doing quite well with net profit growing 20 per cent for the half year ended September 2002. However, compared with peers, HDFC appears to be losing market share. Yet, it remains the largest housing finance company in the country and among the few in good health. Again, this alone is reason enough to stay invested. More importantly, the company has a strong and established brand value that peers can't compete with in the next few years. The worrying part is that the company has not been able to deploy its funds in a profitable manner. In the absence of optimal allocation of funds, HDFC will be whittling down shareholder value. Therefore, it is of great importance that HDFC is able to undertake its buyback. Having said that, the market for housing loans is growing at a steady pace. So it may not be too difficult for HDFC to show a 20 per cent growth in bottomline in the next couple of years. At the current price of Rs 617, the stock gets a price multiple of 12.1 times trailing 12 months earnings. Given that the company has lost its monopoly status and growth will not come easy, the stock may not get the same kind of valuations in future. ALSO READ:
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The HDFC management celebrated October 17, 2002, the day the housing finance giant turned 25 years old, by announcing a 1:1 bonus.
He also said HDFC would not need any fresh funds for the next two years and that the capital adequacy ratio, post buyback, will be sufficient to cover the Reserve Bank of India guidelines.