HUDCO IPO Note

MAY 8, 2017, 2017

GH/Client Note/5/2017

Background:

HUDCO (Housing and Urban Development Finance Corporation) IPO is opening today with offer comprising
of 20.4Cr shares in the price band of Rs.56 Rs.60 per share. A discount of Rs.2 per share would be given to
the retail investors and eligible employees. The issue opens today i.e. May 8, 2017 and will remain open till
May 11, 2017.

IPO details:

Subscription Dates May 8-11, 2017

Price Band Rs.56-60 per share, Rs.2 per share discount for Retail investors
Minimum bid (lot size) 200 shares
Face Value Rs.10 per share
Retail Allocation 35%
Listing On BSE and NSE
Objective of the issue Disinvestment or monetization of promoters share
RHP http://www.sebi.gov.in/filings/public-issues/may-2017/housing-and-urban-
development-corporation-limited_34791.html

Business description

Incorporated in 1970 as a private limited company, Hudco is now a Miniratna PSU in the business of
providing loans for housing and urban infrastructure projects. Housing finance loans the Company provides
are classified as loans to social housing, residential real estate and retail finance (branded as HUDCO
Niwas). Under social housing, the ultimate beneficiaries of the loans are borrowers belonging to the
economically weaker sections (EWS) of the society and borrowers belonging to the lower income group
(LIG). Under residential real estate, the ultimate beneficiaries of the loans are public and private sector
borrowers for housing and commercial real estate projects, including land acquisition. It primarily lends to
State Governments and their agencies, which, in turn, extend the finance to or utilise the finance for the
ultimate individual beneficiaries. Under HUDCO Niwas, it provides financing directly to individuals and bulk
loans to State Governments, their agencies and public sector undertakings (PSUs). Hudco also provides
loans under urban infrastructure finance, where it makes loans for projects relating to: water supply, road

14, Bhartiya Krida Mandir, Naigaon Cross Road, Wadala (W), Mumbai, MH, 400031
+91 98200 62804, +91 99201 66558 I info@greenhillcapital.in I @GreenHill_Cap
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and transport; power and emerging sectors, like SEZs (special economic zones), industrial infrastructure,
gas pipelines, oil terminals and telecom sector projects etc.

Total loan portfolio was Rs.363,858 Mn as on December 31, 2016, of which ~30.9% are housing finance
loans and ~69.1% are urban infrastructure finance loans.

Industry background

The primary business of Hudco is linked to housing, one of the main ideas under infrastructure
development for the current Modi Government. India had an estimated population of 1.3 billion in FY15
with one of the largest and youngest workforce in the world. The country is also undergoing a massive
wave of urbanization with more and more people moving to towns and cities in search of better
economical prospect.

As per ICRAs report Indian Mortgage Finance Market-Update for Q1FY17, the total housing credit
outstanding in India as at June 30, 2016 was around Rs.12.8 trillion compared with Rs.12.4 trillion as at
March 31, 2016, indicating a year on year growth of 19%. In ICRAs opinion, the housing finance sector will
register a growth of around 18% to 20% in FY 2017, compared with the 5-year CAGR of 18% (FY 2011 to FY
2016).

Historical growth data for housing credit:

(Amount in Rs.Billion, except for percentages)

Source: Hudco RHP

Such high historical growth rates are likely to be supported by a healthy growth in the Affordable Housing
segment with some pick-up in primary sales and new launches. The long-term theme working out in favour
of housing credit industry is based on following growth factors: (a) Steady increase in mortgage penetration
levels, (b) Increasing urbanization and population growth, (c) Shortage of housing, (d) Tax benefits and (e)
Favourable regulatory environment and government schemes
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Financials

Unlike the industry and its competitors (mainly the housing finance companies), the Company has grown at
a slower pace. Its revenue grew from ~Rs.2778.6Crs in FY12 to ~Rs.3302Crs in FY 16, registering a
Compounded Annual Growth Rate (CAGR) of ~4.4%, while net profit after tax grew little higher at a CAGR of
~5.7% from Rs.622Crs in Fiscal 2012 to ~Rs.775Crs in Fiscal 2016. The five-year average PAT margin was
23.3%

On return ratios front, again, the picture is not that rosy. The Return on equity (RoE) has remained in 9%-
11% range with FY16 RoE of 9.2%:

INR in Crs. FY16 FY15 FY14 FY13 FY12 CAGR

Revenue 3,302.3 3,427.9 3,002.9 2,921.3 2,778.6 4.4%
PAT 775.3 768.3 734.0 699.7 621.6 5.7%
PAT margin 23.5% 22.4% 24.4% 24.0% 22.4%

EPS- diluted (Rs/Sh.) 3.87 3.84 3.67 3.50 3.10


RoE 9.2% 9.9% 10.3% 10.7% 10.4%

Book value 42.1 38.9 35.6 32.5 29.9
Source: HUDCO RHP, GHC research

Asset quality:

Hudco, as a lender, has been equally hit by bad loan menace: as at December 31, 2016, the gross NPAs
were 6.8% of the loan portfolio, compared to 6.68% of the loan portfolio as at March 31, 2016. The net
NPAs as at December 31, 2016, were 1.51% compared to 2.06% as at March 31, 2016. Against these NPAs,
the Company had made provisions of 70.6% as at March 31, 2016.

Valuation:

The issue is priced at Rs.56-60 per share with Rs.2 per share discount for retail investors and eligible
employees. Using basic & diluted EPS of Rs.3.87 per share as of 31.03.2016, the price to earning (P/E) ratio
works out to 15X. Using annualized numbers for 9M FY17, the PE works out to be 18X.

On price to book (P/B) basis, the valuation works out to be 1.38X using book value of Rs.42.1 as at March
31,2016 and 1.3X using 9M FY16-17 numbers.

Historical growth has remained muted while profit margin has come down in last five years. Additionally,
the Companys gross NPAs and net NPAs have remained steady but at a higher % value compared to many
of the well run HFCs, Hudcos nearest competitors. Finally, low double digit or single digit RoEs (FY16 RoE of
9.2%) do not support any high valuation.

Looking at all the above parameters, we feel pricing of the offer has been fair.
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Relative valuation basis: Though there are no comparable listed in India, we can consider housing finance
companies as Hudcos closest comparable. Since housing has been a major beneficiary of the central
governments push for infrastructure development, most of the lenders active in this space have already
achieved elevated valuation. Just to put in perspective, Dewan Housing, a smaller player trades at 2.6X P/B
ratio while LIC housing, another large player, trades at P/B of 3.7X. However, investors should keep in mind
that these players either have achieved much more growth or have better return ratios compared to Hudco
to justify their valuation

On relative valuation basis also issue seems to be fairly priced

Observations:

Positives:

Industry growth prospects: There has been a great push from the Indian Government to provide
housing for all the people. The sector has received attention post governments launch of Housing For
All scheme, where it plans to build 20 million urban homes and 30 million rural homes by 2022.
Considering housing as a basic need (Roti, Kapada aur Makaan), an attractive subsidy scheme has also
been launched to make the dream of owning a house a reality. Apart from this, there has been a
constant thrust on development of urban infrastructure like water supply, sewerage, drainage, road
etc. where Hudco has developed an expertise in project funding. All this should lead to greater demand
for funds from Hudco, meaning a good growth potential for a longer period of time

Attractive financials: Hudco has been beneficiary of lower cost of borrowing due to its AAA rating,
leading to better margins. The Company is one the few organizations who can issue tax free bonds,
leading to low cost funding options. Hudcos net interest margin (NIM) has been in north of 4% thanks
to lower costs and better credit management.

Though GNPA levels are high, the company has maintained better provision ratios (more than 70%)
which is better for investors from risk perspective. Since the Company experienced NPA issues with
lending to private players, it has stopped lending to them since 2013 and continued lending only to
state/central institutions. This should also lead to lower provisioning in future, providing fillip to its
earnings and balance sheet strength

Issue pricing: As we outlined earlier, Hudcos revenue & profit growth doesnt excite us, while balance
sheet quality and return ratios are also not industry beating. However when we look at pricing, the
issue seems fairy priced. If the Company continue to participate in governments housing scheme push
and achieve lower NPA levels, it will disproportionately improve profitability and return ratios, leading
to higher price levels. This gives us some comfort that there is still money to make on this counter for a
long term investor

Negatives:

Small free float: The government is making disinvestment of just 10% of its shareholding through this
issue. This will leave a small free float in the market, resulting in not much participation from all types
of investors. At times this will act as a deterrent for bigger players to invest in Hudco

Competition: Though there is no major competition to Hudco in financing to state institutions, current
Governments thinking on market based industry /lending may open up this sector to private players
or may impact few of low cost funding sources of Hudco. These changes may impact margins of Hudco

Valuation: Though the issue valuation is not very expensive, long term attractiveness can only come
with better growth, better costs to income ratio and/or lower provisions in future. All these factors are
unproven as of now, and some of them may have already been priced in the valuation, so there is still
an opportunity risk in committing funds for Hudco for a long term investor

In summary, Hudco issue looks to be fairly priced, leaving some money on the table for the investors.
Looking at current buoyant market, the IPO is likely to be over-subscribed many a times while any
listing gains remains to be seen. On an overall risk-return basis, Investors may SUBSCRIBE to the
issue.

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