HDB IPO: How investors may read India's biggest offer of the year

HDB Financial Services IPO: A Risky Bet?

HDB Financial Services Ltd.'s ₹12,500 crore IPO, the largest of 2024, is hitting the market amidst subdued investor sentiment. The three-day offering, opening Wednesday, prices shares at ₹700-740, a price point that has seen significant market convergence since its initial announcement.

The elephant in the room: profitability. HDB's return on assets (RoA) significantly lags competitors. Its red herring prospectus reveals challenges stemming from rising operational costs and managing non-performing assets (NPAs).

Narendra Solanki, head of fundamental research at Anand Rathi Shares, notes the IPO price reflects these risks. He points out that more profitable peers boast significantly higher price-to-book (P/B) ratios. Analysts highlight a valuation of 2.7 times HDB's projected FY27 loan book value, compared to Bajaj Finance's 4.3 times.

• Bajaj Finance: A Tale of Two NBFCs: A stark contrast emerges when comparing HDB to Bajaj Finance. Bajaj, India's largest NBFC, boasts a customer base five times larger (19 million) and a loan book four times the size (₹1.07 trillion). Its fully digital model yields a 5% RoA and a remarkably low GNPA of 1.2%.
• HDB's Strategy: HDB, employing a hybrid model focused on tier-4 and rural consumers, reports a 2.1% RoA and a 2.3% GNPA. Over 70% of its borrowers are underserved, presenting a higher risk profile.

Growth Potential: Despite the challenges, analysts foresee significant growth potential. India's expanding digital landscape and rising credit demand are expected to fuel HDB's expansion into underserved markets. The company's customer base has grown at a 26% CAGR over the last two years.

Jaykumar Shah, CFO at HDB Financial Services, highlights the potential for rapid growth in the consumer finance sector. While 73% of HDB's FY25 loan book is secured, the company is increasing its unsecured consumer lending.

Concerns Remain:

• High Borrowing Costs: HDB's average borrowing cost (7.9%) exceeds that of competitors, impacting its net interest margin (NIM).
• Cost Inefficiencies: HDB faces a high cost-to-income ratio, partly due to back-office services for HDFC Bank. Cost-cutting measures are underway but their effectiveness remains to be seen.
• Asset Quality: Rising credit costs and GNPA ratios raise concerns about asset quality, particularly given the impact of inflation on borrowers.
• HDFC Bank's Stake: HDFC Bank's significant ownership (currently 94.4%, to be diluted to ~74% post-IPO) could lead to an oversupply of shares, limiting upside potential. Further dilution to comply with RBI regulations is also a concern.

Analyst Opinions: Several firms express caution, citing limited upside at current valuations and recommending a wait-and-see approach until asset quality and operational efficiency improve. Investec, for example, labels the IPO a "tactical bet only."

The Verdict: The HDB Financial Services IPO presents a complex picture. While significant growth potential exists, investors must carefully weigh the risks associated with its relatively lower profitability and higher asset quality concerns.