HDFC: Book profits

Recommendation: Book profits

Sanjiv Shankaran

HOUSING Development Finance Corporation (HDFC) presently trades around Rs 510, up by Rs 318 (166 per cent) since May 1999.

At the current price level, shareholders may consider booking profits in the wake of increasing competition in the housing finance industry, long gestation periods in HDFC's critical new ventures and technical factors pertaining to the equity market. Given the high quality of the underlying business, investors may consider an exposure if the stock price falls significantly from the current levels.

HDFC has been the dominant player in the market for housing loans. Recently, the company initiated moves to consolidate its position in the market by buying out Hometrust Housing and increasing its stake in Gruh Finance. Currently, HDFC holds about 54 per cent in Gruh.

Over the last couple of years, the market for housing loans has become more competitive following the entry of ICICI Home Finance and a few top rung non-banking finance companies (NBFCs).

While the entry of new players has not in any way significantly reduced HDFC's domination in terms of volume, the increased competition has led to the frequent use of interest rate as a tool to increase market share. This indicates that in future there is likely to be little scope for an improvement in spread (the difference between interest expense paid out and interest income earned). Over the last couple of years, HDFC's spread has shrunk from about 2.06 per cent to 1.84 per cent in 1999-2000.

HDFC's track record is among the best in the financial sector when it comes to containing risk. In 1999-2000, the company reduced the quantum of loans where payment was in arrears to just 0.90 per cent of its portfolio.

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Low risk associated with its business, and the high standard of service -- an important factor in determining success -- has played an important role in the relatively high valuation HDFC's stock has commanded in the equity market. But the evidence of increasing competition may lead to lower valuation in the future because earnings growth may slow down.

HDFC has traditionally deployed about 25-30 per cent of its funds in investments other than housing loans. This is done, among other things, to ensure liquidity support to the core business. The returns on other investments has provided a big quantum of income in the past. With its entry into the insurance sector in association with Standard Life Assurance, the future growth from other income may slow down because the insurance business requires long gestation periods and huge investments.Other than the fundamental factors that may result in a slowdown in future earnings growth, HDFC's share price may also be affected by factors peculiar to the equity market. In March, HDFC initiated steps to allow foreign institutional holdings in the company up to 40 per cent; a move followed by over 25 per cent appreciation in share price.

The market's track record suggests that a lot of temporary positions in a blue chip is built-up in anticipation of increased foreign investment flow. This may well be followed by a fall in share price if the expectations fail to materialise. Shareholders may consider using the present situation to book profits in HDFC because future valuations may be at slightly lower levels.