Crisil amongst early beneficiaries of capex revival

The largest ratings company is well poised to benefit from improved macro, bond market growth, but the market has already factored in these gains

The share price of credit rating agency Crisil has outperformed the benchmark Sensex in recent months. The company and other rating agencies stand to benefit from potential pick up in private sector investment as India Inc. will need more loans. This, in turn will push demand for individual project ratings which is crucial for obtaining bank credit. Thus, rating companies are among early beneficiaries of an investment pick up. Further, the regulators have been focusing on promoting corporate debt market for the past two years. Some of the steps taken in this direction relaxation in investment norms for EPFO (allowing it to invest in bonds of select public and private sector companies), permitting insurers to invest in papers rated ‘A’ or lower, reduction in withholding tax for FIIs in debt from 20 per cent to 5 per cent and raising FII limit in the debt segment. This along with likely easing of interest rates and higher growth in small and medium enterprises segment will augur well for ratings agencies.

Given its dominant position in the ratings industry (revenue market share of 35 per cent), Crisil is well poised to gain from improving macros. Care and Icra command 28 per cent and 20 per cent revenue market share, respectively in the ratings industry. Crisil's strong parentage (US-based Standard and Poors), robust profitability and high cash generation are its key strengths. Crisil also earns significant revenues through research, advisory and risk solutions related activities, which should also do well, going ahead. Diversified revenue and margin mix also cushion the company during adverse economic cycles.

"Unlike CARE and ICRA, which are highly dependent on domestic ratings for revenues as well as operating profits, Crisil is more diversified with revenues across research, rating, advisory divisions and across geographies (India, UK, US). Diversified revenue stream helps reduce cyclicality in its revenue and profitability", says Jignesh Kamani, analyst at Nirmal Bang Equities.

Rating industry: SME the key growth driver

Currently, bank loan rating contributes highest to ratings revenues (over 50 per cent of rating industry revenues). However, going forward analysts expect the under penetrated segments of corporate bonds and small and medium enterprises (SME) to catch up. Corporate debt market forms a mere 3.9 per cent of India's GDP as against 10-40 per cent of GDP of other emerging markets and has a huge potential of scaling up. Likewise, out of the 25 million SMEs, only 0.3 per cent have got rated - thus, making most rating agencies bullish on this segment.

Among revenue risks for Crisil and other rating companies is the adoption of internal rating based (IRB) approach by banks in tune with Basel-II norms. But, analysts are not worried. "Interaction with bankers (both private and PSU) suggests limited risk of revenue loss from migration to IRB approach in the immediate future. Industry experts believe only 50 per cent of banks will be able to migrate to IRB approach in the next 3-years", says Aalok Shah of Centrum Broking. Others add that the process will only be gradual.

Expensive valuations

Going forward, analysts expect the company's revenues and net profit to grow 15 per cent and 16 per cent, respectively this fiscal. Improved traction in ratings business (36 per cent of consolidated revenues) along with healthy growth in research revenues (59 per cent of consolidated revenues) will drive the company’s performance in the coming years.

In the advisory business, albeit a small contributor, Crisil works with regulators and governments, multilateral agencies and companies to shape public policy and establish viable frameworks to enable infrastructure development. It also provides a complete range of risk management tools, analytics and solutions to customers in India, Middle East, Africa, South Asia, and South East Asia. The advisory and risk solution division reported CAGR revenue decline of 11 per cent over CY08-CY13 at Rs 56 crore. The company had maintained cautious outlook on this business post March quarter results, but with the new government in place, this segment’s prospects hopefully should start looking up.

Meanwhile, at current market price of Rs 1,780, Crisil is trading at 45.8 times which is a huge premium over its historical average (five years) one-year forward price to earnings ratio of 19.9 times. Most analysts polled by Bloomberg since May this year are positive on the company, but their average target price (Rs 1,450) is about 19 per cent lower than current price. While there is no immediate upside, long term investors can consider the stock on significant correction.