HDFC’s balance sheet witnessed a healthy growth of 24.7% year-on-year (y-o-y) during the recently concluded quarter to Rs851.6 billion. For the year, while loan approvals increased 29.6%, loan disbursements witnessed a rise of 27.6%.

The company has been successful in keeping its loan growth largely in line with its yearly target of about 25%. Its loan’s CAGR for the period FY2003-08 stood at 27%.

Net interest income (NII) surged 36% y-o-y to Rs6.5 billion, led by the 31% increase in loan book. However, spreads witnessed a decline of 13 bps y-o-y to 0.61% as the cost of funds increased 9 bps. Cost of funds rose on account of rise in interest rates on monetary instruments such as bonds and commercial paper etc.

While so far the growth has been very impressive, we believe that the present economic scenario, which is distinguished by a slowdown and record inflation levels, poses a threat to HDFC’s business, as demand for housing is witnessing a fall.

However, we expect the company to weather the storm on account of it having a larger presence in small and middle ticket loans – where the demand has fallen less than that in the high segment. At the same time, we expect the advances growth for this FY09 to fall, after factoring in the rising interest rates.

Our target price of Rs2,828 for FY09E for HDFC is based on the sum-of-parts valuation methodology. We have arrived at a per share value of Rs1,905 for the standalone banking business using the three-stage discounted Equity Cash Flow method. We have assumed a 13.5% cost of equity and a terminal growth rate of 12.36%.