LIC Housing Finance trades at 50% of the book value of HDFC which is excessive given that it is lower than HDFC is just one out of five key metrics, says Espirito Santo Securities
LIC housing Finance (LICHF) has underperformed the Bankex over the last six months, given the switch out of defensives and also the consistent decline in NIM (Net Interest Margin) as LICHF has struggled to increase its builder loan book. However, Espirito Santo Securities expects NIMs to slowly expand by 40bps over the next four quarters with no negative impact on credit quality. It believes that LICHF will be a consistent performer with 20% loan book CAGR (compounded annual growth rate) and 20% stable state ROE (Return on Equity).
“We value LICHF on an excess return on equity method and increase our valuation from Rs280 to Rs308, mainly as a result of rollover from FY13E to FY14E, implying 23% upside from the current levels. This implies a 1.9 times FY14E P/B multiple. Currently the stock trades at a more than 50% discount to HDFC core book value which we think is excessive given a higher growth rate and in our opinion more defensive book,” said Espirito Santo in a research note.
HDFC is considered to be the benchmark in the housing finance sector given the consistency of earnings and sustainable growth rate; hence the brokerage has compared LICHF with HDFC on five key metrics (consistency, transparency, brand name and customer service, distribution and quality of book). Despite the valuation discount, LICHF rates consistently lower than HDFC on only one of these metrics.
“HDFC’s ROA and ROE have been more consistent than LICHF’s, but the book value growth rate is more consistent and higher on an organic basis for LICHF; we would rate LICHF’s disclosure standards as better than HDFC’s; LIC’s agency base is one of the most potent and efficient distribution forces in India and LICHF has one of the most efficient operations with its opex/AUM (operating expenses to assets under management) ratio now below HDFC’s. It might not be HDFC, but in our view LICHF is a very strong housing finance company,” Espirito Santo said.
Consistency is observed in return on equity (ROE) and return on assets (ROA) over the years, and LICHF has performed well in comparison with HDFC and Dewan Housing. LICHF has significantly improved the quality of its loan book as well as systems and controls over the last five years leading to consistently declining NPLs (non-performing loans), which are now at par with HDFC at 0.42%. LICHF has consistently delivered loan book growth in excess of 20% over the last five years, and better than HDFC. The graphs below are indicative of how LICHF fares on the consistency metric.
Transparency in LICHF has improved in recent times. The company’s disclosure levels are rated as the best in the industry, with all the income and expenditure passing through the P&L, compared with the peer group which charges some provisions directly to the Balance Sheet. Also, quarterly disclosure levels are industry leading.
The company has now entirely put the shock of its previous CEO’s arrest in December 2010 ‘bribe for loan’ behind it, and handled the issue in a mature manner. Overall transparency and behaviour towards minority shareholders are considered to be good.
LICHF has a strong distribution network with a presence in more than 450 locations across India with around 210 offices across the country. More than 60% of the loans are originated through home loan agents (agents of parent life insurance company, LIC). As the largest life insurance company in India LIC has more than 1.3m agents and hence offers great potential growth opportunities at very low cost to LICHF. LICHF has hired less than 10,000 agents of LIC as of March 2012. Moreover, this is a tied agency for LIC, with relationships spanning more than a decade in the majority of cases and hence likely to be loyal and know the profile of customer’s better than any other channel.
HDFC originates bulk of the loans through HDFC Sales Pvt. Ltd (wholly owned subsidiary) and HDFC Bank. Both of these distribution networks have worked superbly well for HDFC. But LICHF’s distribution is equally strong and efficient, concludes Espirito Santo Securities.
“The only flaw which we can see in LICHF is that it is akin to a PSU given LIC ownership, and hence there could be negative perception amongst investors about quality of management. Hence, we expect the stock to continue to trade at a discount. However over time, this discount is likely to shrink as investors become convinced about the quality of the franchise.”
“Other than the macro factors that concern the entire housing finance sector, our investment case on LICHF mainly depends on an increase in NIM from hereon given conversion of teaser rate loans into floating rate loans. However, there is a risk -- if there is no NIM expansion, due to an increase in the cost of funds, or if the teaser rate loans start getting prepaid,” points out Espirito Santo Securities in its risk analysis.
The brokerage points out that “given the LIC (Life Insurance Corporation of India) name attached with LICHF (LIC Housing Finance), the brand is clearly strong, as is the credit rating, meaning a consistently low cost of funds and a high level of customer trust. Channel checks suggest that service levels are superior to PSU (public sector undertakings) banks. The company’s agents provide a doorstep service to the borrower. The processing time is longer than private HFCs (housing finance companies) but much better than PSU banks. However, on this metric it is inferior to the peer group as well as some of the private sector banks.”