IPO analysis: Strong prospects for ICICI-Sec, but correlated to markets

Although valuations are rich, most analysts are positive due to rising financialisation of Indian savings

At a time when the stock markets are near all-time highs, many would want to invest in ICICI Securities (I-Sec), the country's largest equity broker since 2013-14, based on brokerage revenue and active customers on the National Stock Exchange.

A leading technology-based securities services provider, it is hitting the primary market with a Rs 40-billion Offer for Sale by its promoter, ICICI Bank. However, the Initial Public Offer (IPO) valuations are rich and leave little for immediate investor gain. While the high correlation between its financial performance and market trends is a potential risk.

Strong business

I-Sec was among the pioneers of electronic trading in securities, a platform it started as early as 2000. It offers a wide range of services -- securities broking, financial products distribution, etc. Its proprietary e-trading system allows it to quickly address customer needs in a seamless and cost-efficient manner.

Likewise, its open-source distribution platform is an advantage. “I-Sec has built its e-brokerage platform using a plug-and-play architecture, so that they can easily integrate it with internal systems and those of third parties whose products they distribute,” says Axis Capital in a note. All this helps in keeping a tab on costs and earning of higher margins.

Today, I-Sec services a growing pool of 4.6 million customers (as on December 31, 2017) and 3.9 million operational accounts under its e-brokerage platform, ICICIdirect.com. It also gets revenue from investment banking. Given the strong record and prospects, most analysts are positive on the offer. “We have a ‘subscribe’ view, given the potential improvement in equity participation, shift in savings habits of individuals towards the equity market, growing distribution income, potential growth in brokerage income, etc,” says Vineeta Sharma, research head at Narnolia Securities.

Robust financials
 

I-Sec posted an 18.8 per cent compounded annual growth rate (CAGR) in total income during FY13-17. Brokerage income, a little over 55 per cent of revenue currently, grew 17.6 per cent in FY17 and around 32 per cent, year-on-year, in the first nine months of FY18. Analysts believe the brokerage sector's revenue should grow at a CAGR of 15-18 per cent but rising competition from very low-cost brokerages is a risk.

I-Sec’s net profit grew at a CAGR of 45 per cent during FY13-17; it has grown fast in FY18, too. A net profit margin of over 20 per cent in the past three years (29.6 per cent during the first nine months of FY18) is enviable, higher than peers Edelweiss Financial Services, IIFL Holdings, Motilal Oswal Financial Services and JM Financial. This has helped I-Sec deliver handsome return on equity (RoE) — 69.2 per cent in FY17, as against peers' 14-20 per cent. However, many of the competitors are also well diversified (presence in housing finance, etc) and, so, are less vulnerable to market trends.

A look at past data shows I-Sec’s total income is susceptible to market trends (see chart). So, any major reversal in the current bullish trend might have a bearing on its financials. In FY09, FY12 or FY16, for instance, when bears outperformed bulls in the market, I-Sec's earnings fell. The management, however, says its technology platform, ICICIdirect, offers operating leverage, protecting I-Sec’s earnings.

While the high correlation of its earnings and markets is a risk, I-Sec’s growing distribution income from mutual funds, insurance, pension products, etc, does offer some cushion. “The share of non-brokerage income grew from 30 per cent in FY13 to 37 per cent in FY17 and product diversification within the distribution segment will continue,” says Shilpa Kumar, its managing director.

Sector dynamics

The changing investment habits in India also augur well. “Financial savings are moving from physical to financial assets. Since the interest rate on bank deposits have been lowered, people are moving to equity and mutual funds,” Kumar adds.

Analysts also point to the low penetration levels. “Capital market-related companies account for only 1.2 per cent weightage in the BSE S&P 500 index, compared to 3 per cent in the US’ S&P 500 index and 4.4 per cent in China’s Shanghai Composite index. This gap suggests the growth potential for companies like I-Sec,” said Sharma.

Expensive but comparable

While there is little doubt of the expertise and leadership of I-Sec in its business, the IPO is currently valued at 49 times the company’s FY17 earnings and 31 times its estimated FY18 one. Barring JM Financial, other peers such as Edelweiss Financial, IIFL Holding, Motilal Oswal Financial and Geojit Financial are valued at 36-46 times their respective FY17 earnings but they also earn a lower RoE.

While most analysts are positive due to the long-term prospects of the business, some are sceptical. “The IPO is very expensive. So, let the market decide its fair price,” says Arun Kejriwal, founder, KRIS.

Patient investors with the appetite to ride market volatility could subscribe.