HDFC and it's Warrant for profit
Updated: Oct 12, 2020
HDFC established as "Housing Development Finance Corporation Limited (HDFC)" in the year 1977 to provide specialized mortgage in India, needs no introduction. Today, it has emerged as one of India's largest and leading financial institutions with a presence in banking, life and general insurance, asset management, venture capital, realty, education, deposits and education loans.
The institution has consistently remained profitable and we strongly believe that would not change anytime in the near future.
We have been conservatively optimistic about future prospects (even at the CMP of 1958/sh) of the institution for the following major reasons:
Average ROA of 4.29% and a 5-year average ROE of 19.2%
The future prospects, of the
At 1958/sh the stock is trading at:
PE of 15.1x against its average of 20x
Price to BV of 2.1710x against its longterm average of 3.6468x
EV/5YrAvg EBIT of 17.7448x
Considering this post is more about the strategy, so moving ahead
What is a Warrant?
Warrants are a derivative that gives the right, but not the obligation, to buy or sell a security—most commonly equity—at a certain price before the expiration. The price at which the underlying security can be bought or sold is referred to as the exercise price or strike price.
- as defined by www.investopedia.com
In the wake of the Covid-19 situation the institution like most others raised capital and in the same capital-raising they issued warrants which currently trade on the bourses.
The mortgage lender also issued 1,70,57,400 warrants at an issue price of Rs 180 per warrant. The warrant holders can exercise their right to exchange each warrant for one equity share at a price of Rs 2,165 per warrant at any time before the expiry of a period of 36 months or until August 10, 2023, it added.
Unlevered position for levered returns !!!
The current price of the 'W3' Warrant of HDFC closed at 332.4/- on October 9th, 2020.
Buying the warrant allows you "the right, but not the obligation" of buying the equity of "HDFC" at the exercise price of 2165/sh "before or until"August 10, 2023.
Effectively costing you 332.4+2165=2497.4/sh, while the stock closed at 1958/sh.
"How does that make sense?"
The warrants are trading at ~17% of the current price, implying a worst-case downside of the entire principle of the warrant cost- viz-17%. However, considering HDFC does achieve our 3yr target of 3288.32/- (viz.- an annual stock price growth rate of 19 %), the same warrant would be trading at greater than 3288-2165=1123/ warrant which would imply a return of 1123/332.4-1 = 237.84% (viz.- an annual stock price growth rate of 50 %).
Limiting the downside "in the worst-case" to the entire sum invested while magnifying returns on the upside.
However, in the case, the HDFC Stock closes below 2165/sh on August 10th'2023 the warrant would expire worthless and the buyer would only incur a profit if the stock closes above (2165+ Cost price of Warrant).
#Disclosure: The above post is purely for presentation and must not construe investment advice. Please consult your financial adviser. The author, his associates & clients may hold positions in one or all instruments discussed. Capital Markets are risky.