Beyond broking

Broking firms are diversifying their revenue stream to survive stock market volatility.

When most investors who put a part of their kitty into the markets were left with tattered pockets, the fate of broking companies whose bread and butter is dependent on the markets can only be left to imagination till the next quarter results reveal the true picture.

Though the general sentiment in the stock markets impacts most stocks similarly, the stock price movements of the broking firms have shown high correlation with the indices.

What all this means is that these stocks, on their own, have little control on their performance. Since the revenues of these companies are a direct function of the overall trading activity in stocks, their direction is determined by the course of the market. What happens in a volatile market or worse, when the market dips?

The boom in the market till mid-May made stocks of broking houses attractive as a lot of growth was visible in these stocks. But consider the fall from mid-May levels and the subsequent recovery post mid-June and one finds that the Sensex is just three per cent below its peak.

But broking stocks have a lot to catch up. IL&FS Investment Managers is trading 17 per cent lower than what it was trading while the Sensex was at its peak.

Average weekly trading volumes of broking stocks are around 60 per cent lower than peak levels, showing the waning interest in these stocks. The volumes of Indiabulls are 66 per cent below its mid-May levels. 
 

LAGGING BEHIND
(%)	Sensex	EMKAY	IL&FS	India Infoline	Indiabulls
Fall in prices	-2.98	-44.31	-17.28	-16.24	-8.92
Fall in volumes	-32.12	-54.12	407.12	-62.45	-65.49

For most of the broking houses, a majority of their revenue comes from equity broking. For a company like Emkay Shares and Stock Broking, equity broking contributed a huge 85 per cent in FY06 revenues, while 67 per cent of India Infoline's revenues came from equity broking.

Also, in a bid to offer more investment related services to customers and to simply keep pace with competition, most houses have started offering other equity-related services like portfolio management services (PMS) and distribution of mutual fund products.

Though these are fee-based activities, such businesses also tend to be dependent on the mood of the markets.

Their vulnerability was paticularly evident in the June quarter numbers when growth showed a slowdown. Sales of Indiabulls showed a growth of 57.78 per cent q-o-q in the March quarter, but they declined 11.46 per cent in the June quarter. 
 

SALES GROWTH
Q-o-Q growth (%)	Jun 06	Mar 06	Dec 06	Sep 06
Indiabulls	-11.46	57.78	-22.53	26.21
India Infoline	6.18	33.76	20.64	142.64
IL & FS	55.07	-12.49	40.03	14.20

Even in the case of India Infoline, sales were up 33.76 per cent in the March quarter, but were up only 6.18 per cent in the June quarter.

However IL&FS showed more resilience perhaps because of its institutional broking business. While in the March quarter its sales had dipped 12.49 per cent, they grew by 55.07 per cent for the June quarter.

The near-term worry though is that performance of these companies could suffer in this quarter too. After the May fall, though stock prices have almost fully recovered, trading volumes on the bourses are still substantially short of peak volumes. BSE volumes are 32 per cent below what they were in mid May. Broking firms presumably would have seen a fall in business as well.

So far, thanks to the booming market, these firms have seen rapid growth. Indiabulls' topline saw a y-o-y growth of 263.69 per cent to Rs 610.34 crore for FY06, whereas India Infoline's sales grew by 182.32 per cent to Rs 215.21 crore.

Their bottomlines too have surged. While Indiabulls' profits were up 346.78 per cent to Rs 253.37 crore, India Infoline's have increased 125.69 per cent to Rs 48.93 crore.
 

FINANCIALS (FY06)
	Emkay	IL&FS	India  Infoline	Indiabulls
Sales (Rs crore)	46.01	212.81	215.21	610.34
y-o-y growth (%)	-97.93	82.28	182.32	263.69
y-o-y growth (FY05) (%)	69.55	146.36	119.81	133.34
Net Profit (Rs crore)	15.46	69.12	48.93	253.37
y-o-y growth (%)	134.60	109.07	125.69	346.78
y-o-y growth (FY05) (%)	62.32	189.87	189.84	193.07

With competition getting stiffer and the pace of business slowing down, broking firms face another challenge of sustaining broking rates. Going forward, income from non-equity based sources will matter more.

Having realised their vulnerability to the risk prone equity markets, broking firms are getting into other businesses that ensure a certain amount of revenue to keep their head above water even during bad times. 
 

PROFIT GROWTH
Q-o-Q growth (%)	Jun 06	Mar 06	Dec 06	Sep 06
Indiabulls	-20.03	48.16	-22.4	4.51
India Infoline	14.22	46.06	6.77	150.53
IL & FS	54.63	25.35	8.20	28.12

For instance, India Infoline is aggressively growing its insurance distribution business apart from pursuing investment banking operations.

Indiabulls is trying to transform itself into a financial services power house. In FY05, 66.2 per cent of the company's revenues came from the broking business, whereas in FY05 it contributed only 53.85 per cent.

India Infoline, too, is trying to achieve a 50:50 mix. Says Nirmal Jain, CMD, India Infoline, "Our goal is to reduce the dependence on equity to 40-45 per cent in the next three years."

The market too is rewarding only companies that are reducing their dependence on the stock market as their primary growth driver.

This is evident from the instance of Emkay that is currently trading at Rs 71.10, 41 per cent below its issue price of Rs 120. Since the firm is entirely dependent on its equity business, the stock has been hit the most during the recent fall.

Indiabulls Financial Services, earlier predominantly focused on equity broking, has got into the consumer financing and real estate businesses.

In fact, analysts see these businesses as the growth drivers rather than the broking business. Already, the firm is showing scorching pace of growth in its new businesses.

In Q1FY07, the outstanding loans of Indiabulls grew at 705 per cent y-o-y to Rs 238.59 crore. The consumer finance business is expected to contribute 35-40 per cent to revenues by FY08 as against 6 per cent contribution in FY06.

Besides, analysts see Indiabulls' real estate business as a value generator in the long run. The company had recently announced that it would demerge its business into a separate publicly traded entity - Indiabulls Real Estate.

Shareholders of Indiabulls Financial Services would get one share of Indiabulls Real Estate for every one share of Indiabulls Financial Services held. The demerger is expected to be completed in Q3 FY07.

The company also plans to invest around five per cent of its consolidated net worth towards new business opportunities mainly in the area of conventional and renewable energy.

Similarly, India Infoline which derives 67 per cent of its revenues from equity broking is increasing its focus on insurance and commodity broking.

Despite a 70 per cent growth in the mutual fund distribution business in FY06, the share of this business in overall revenues fell to 9.37 per cent from 15.54 per cent in FY05 due to a stronger growth of 179 per cent in the equity business.

Currently, India Infoline is the largest corporate agent of ICICI Prudential, the largest private life insurance company in the country. Insurance currently chips in 10 per cent to the revenues.

India Infoline foresees tremendous opportunity in this space going forward too. At present the company distributes only life insurance products, but it wishes to get into the general insurance space too.

This income from policy commission in a way provides predictability and stability to future revenue flows. Revenue from insurance is expected to double to around Rs 45 crore in FY07.

Besides, the company has forayed into investment banking through the acquisition of Marchmount Capital Advisors in December 2005. On the investment banking side, the company is focusing on the SME segment.

"We feel that while the large enterprises would have established merchant bankers to go to, SMEs would not be able to get a decent hearing and service levels as well and this is where they fit in," says Jain.

The company also acquired a 75 per cent stake in Marchmount Consultancy Services that is engaged in distribution of mortgages.

Distribution of mortgages is growing at 35-45 per cent per annum and the company is in a position to easily tap this by leveraging on its existing customer base and network.

The good part for IL&FS and Emkay is that they derive substantial revenues from institutional broking. In fact for Emkay, they contribute equally to the equity broking income.

Says Krishna Kumar Karwa, managing director, Emkay, "Income from institutional broking in a way de-risks the model. While retail investors enter the market once the momentum is set, institutional investors set the momentum for the market."

However, the stock market does not seem to be buying this argument. At present, retail players are trading at a premium based on FY06 earnings""India Infoline at a P/E of 18.44 times, Indiabulls (46.41 times), IL&FS (13.95) and Emkay (8.13).

Both Indiabulls and India Infoline have a better product and revenue mix as compared to peers. This fact coupled with their healthy growth rates should enable these companies to command higher valuations, feel analysts.

But out of the two stock, Indiabulls looks expensive even though the company has an excellent track record of high powered growth so far.