Event

We revisit HDFC’s earnings forecasts by rolling over into FY3/07 actuals and FY3/10E and incorporating its recent equity placement into the numbers.

Impact

Robust business model.

HDFC Ltd’s mortgage business model is extremely robust. Its lack of a deposit franchise is offset by a super-efficient cost structure, and its superlative asset quality means that it can translate the superior ROA of a non-bank into the leverage of a bank, leading to a top-ofclass ROE. For the last three years, HDFC has shown ROE in the region of 30%, while most banks peak at 22–24%.

Equity issuance – at very strong valuations.

This ROE is now set to fall to the mid-20s as the bank diluted capital via a private placement to Citigroup and Carlyle late last month. This issue was done at an historic P/BV of 7.8x and an historic PER of 28x. This means that its BVPS rises by 65% in FY3/08E, more than offsetting the drop in ROE.

Subsidiaries a key driver.

Subsidiaries now account for 30% of HDFC’s valuations, primarily driven by HDFC Bank and HDFC Standard Life (unlisted). The life insurance business is at an inflexion point; while it saw market share slipping in FY3/07, we expect a strong bounce-back this year as both product and distribution issues are reconciled.

We expect that HDFC’s subsidiaries will continue to contribute significantly to growth over the next couple of years. In fact, HDFC’s non-life sub, which Chubb recently exited as the JV partner, should also start to perform strongly from FY3/09E, once a new collaborator is found. We have not captured this upside yet in our valuations.
Earnings revision

We revise our EPS estimate for FY3/08E downward by 3%, with no change in EPS for FY3/09E. We increase our FY3/09E BVPS by 30% to Rs 417; our FY3/10E ROE stands at 23.6%. Consequently, we raise our target price by 7% to Rs 2,202.

Price catalyst

12-month price target: Rs 2,202.00 based on a Sum of Parts methodology. Catalyst: 1QFY3/08E results - expected to show resilience to a systemic slowdown in home loan growth.

Action and recommendation

HDFC’s P/BV does scare investors – the equity placement brings it down from 8x to 5x. However, with 30% of this coming from subsidiary value, ROE in the mid-teens and consistent 20%+ EPS growth, we find this more than acceptable. We retain our Outperform on the stock and assign it a 6% weighting in our portfolio.