Best Housing Finance Companies To Buy With Upto 43% Upside By Nomura

Mortgage finance: Structural story continues

HFCs well placed – expect strong returns with low asset quality risks

Action: LICHF up to Buy; initiate on Indiabulls, Dewan Housing at Buy

Structural drivers remain in place for mortgage growth in India with penetration still more than 50% lower than peers and cyclically we expect the funding environment to remain favourable. We upgrade LIC Housing to Buy (TP: INR500) as we believe it is the sector’s biggest beneficiary of lower wholesale cost of funds. We initiate on Indiabulls (IHFL) and Dewan with Buy ratings as their consistent performance have led to continuous credit rating upgrades and the funding profile improvement should drive up their competitiveness in prime mortgages. Among larger HFCs, our top pick is LICHF and among mid-sized HFCs, we are more convinced on IHFL.

Structural story continues: HFCs appear well placed

With just ~8% mortgage to GDP penetration and rising income levels, we expect 18% CAGR mortgage growth over the next five years. While competition has remained intense, large HFCs have gained share due to their competitive cost of funds and lower opex structure vs banks and smaller HFCs have built niches in funding low cost housing (ticket size of less than INR1.5mn). HDFC/LICHF should continue to remain as the dominant players and we see smaller HFCs like IHFL graduate to become prominent in prime mortgages as their cost of funds become more competitive.

Cyclically funding environment favourable

We expect wholesale funding environment to remain favourable. While banks, especially PSUs, are re-orienting their focus to retail/mortgages, their ability to cut mortgage/base rates is lower than FY08-10 given their weak profitability (ROAs 0.6-0.7% lower than FY09).For smaller HFCs like IHFL/Dewan, credit ratings upgrades should result in significant improvement in their funding profile and acceptance of their bonds. This should help offset any yield pressure on LAP and drive up their competitiveness in prime mortgages.

Valuations and preference among HFCs

1) Among large HFCs, LICHF’s valuations seem reasonable at 1.9x FY17F book (BVPS: INR212) as improving margins should drive up ROEs to 18-19% in FY17F.

2) HDFC’s valuation at 3.6x FY17F book (BVPS: INR195) is above mean and hence we maintain Neutral.

3) IHFL’s re-rating is likely to continue as ROEs at ~27-28% are best in class, improving rating profile should offset any yield pressure and recent management steps to address weak perception of corporate governance is all positive.

4) Dewan’s focus on low-cost housing is to its advantage and lower profitability vs peers is reflected in its valuation (1x book). Dewan’s use of cashflows have been inefficient in the past and improvement there should drive a re-rating.