Subsidiaries pad up HDFC stock, core biz valuation touch all-time low

Having a motley pool of subsidiaries has its own advantages. While in the initial years, the parent company’s capital may be fast consumed by its subsidiaries, the payoffs could be meaty when they mature. Housing Development Finance Corporation (HDFC), the country’s largest mortgage lender, is the best example to support this.

Its core mortgage business isn’t keeping pace with past records — loan growth at 12 per cent in the July-September quarter (second quarter, or Q2), marking two successive quarters of growth slipping below the 17–20 per cent levels seen in the past two financial years.

Consequently, its financials have received support from subsidiaries. With two of its flagship companies — HDFC Life and HDFC Asset Management Company (AMC) — hitting the bourses in the past two years, profit from the sale of investments has become a significant component, lifting HDFC’s numbers. Save for these gains, the numbers may have looked different, including the recently concluded Q2, where earnings were lifted by over Rs 1,200 crore, thanks to gains from the stake sale in Gruh Finance.

The rub-off effect of subsidiaries is quite prominent on the stock price movement as well. While the HDFC stock has gained 18 per cent year-to-date in 2019, its subsidiaries have outperformed the parent, with HDFC Bank and HDFC Life gaining 20–51 per cent in the same period, while HDFC AMC has seen its stock price more than doubling so far in 2019.

Simultaneously, the value of HDFC’s core mortgage business has fallen by 43 per cent since 2015-16 to 1.35x its book — now at an all-time low. On the contrary, with top quartile gains, the value of subsidiaries to HDFC’s overall valuations have risen manifold to 52 per cent.

Analysts at Morgan Stanley cite that the implicit holding company discount attributed to the value of stakes in subsidiaries has expanded, making it one of the key reasons for the valuation of core mortgage business to derate in recent times, apart from muted loan and earnings growth in recent times.

However, the brokerage believes this doesn’t mean endgame for the holding company in terms contributing to the valuations. “We expect loan growth at HDFC to pick up over the next 12 months as competition from other non-banking financial companies continues to ease and terms for stronger lenders improve further,” the analysts add, while expecting earnings to grow at 22 per cent during FY20-25. Agreeing with this view, analysts at JM Financial say the multi-year low valuation of the core business makes the HDFC stock a compelling buy for long-term investors.

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