LICHF, the No 2 housing finance company in India, has had a tough time recently. A loan graft case in November 2010 and teaser rate loans (July 2009- March 2011) hurt growth and margins. But the company, which generates most of its business from retail mortgages, has made a fresh start by, rebuilding its higher-margin project loans business, which slowed after the graft case; converting the teaser loans, which have made it difficult to pass on higher funding costs to customers, to floating rate from July 2012. We think margins have bottomed and should improve as growth picks up.
We expect the loan book to double over FY11-14 and this, combined with a recovery in spreads, should drive earnings CAGR (compound annual growth rate) of 23%. Our view is based on the resilience of mortgage demand in the face of high property prices and interest rates, diversification into tier-2 cities and the pick-up in projects loans.
FY12 earnings growth is likely to be subdued, with teaser loans still to be repriced, the project loan book only starting to take off again and the high base from a one-off sale of a stake in a mutual fund subsidiary; we look for a FY12-14e (estimated) earnings CAGR of 31%. Our FY13e and FY14e earnings are higher than consensus by 3% and 6%. Over FY11-14, we expect ROA (return on assets) to rise from 1.73% to 1.92%.
Initiate OW(V) (Overweight with volatility). With valuations at two-year lows, we see a good entry point. Better profit and growth prospects should improve valuations to recent mid-cycle multiples, implying 12-month rolling target multiples of 2x(times) PB (price-to-book) and 10x PE (price-to-earnings), up from the current 1.8x PB and 8x PE. This gives us a target price of R287, implying a potential return of 39% (including dividend yield).
We recommend quasi-government-owned LICHF for investors looking for higher alpha, while HDFC may suit those who prefer lower volatility.
Risks: A global financial shock would hurt buying sentiment, affecting our loan growth assumptions.
Housing finance is one of India?s most under-penetrated business segments, representing just 9% of GDP. Over the next few years the country?s large and growing working population, urbanisation, rising income levels, and favourable demographics are likely to keep demand strong.
According to India?s Planning Commission, the urban housing shortage is likely to reach 26.5m units by 2012, up from 10.6m in 2001. We think the fact that the increasingly affluent middle class is becoming more comfortable with taking on debt is a significant driver. Mortgage demand should remain robust as long as the economic outlook is strong.
Housing finance companies (HFS) like LICHF and commercial banks will play a pivotal role in India?s mortgage loan growth story. LICHF, established in 1989, is well positioned across the country to capture the growth in coming years. As a pure domestic lender, it is insulated from the bleak news coming out of Europe and the US.
Loan graft probe: In November 2010, RR Nair, chief executive officer of LICHF, was arrested as part of a Central Bureau of Investigation probe into company officials taking bribes for sanctioning loans. LIC, the parent company, appointed VK Sharma as the CEO of LICHF.
The allegations involved R3.9 bn worth of project loans, representing 8% of LICHF?s total project financing loans and 0.8% of total loans. The stock price fell rapidly, but while the sentiment was negative, the impact on asset quality was minimal. Half of the R4 bn loans in question have been repaid and the balance has suffered no defaults.
As a defensive measure LICHF reduced its exposure to project financing significantly. Two quarters later, LICHF has again started to approve project finance loans.
We expect loan growth to improve from 5% in FY11 to around 30% over FY12-14 with the project financing share rising from the current 7.5% to 9% by FY14.
?HSBC Global Research