RESEARCH Credit Analysis and Research PCG... · growth of the country has also plunged 63-year low...

PCG RESEARCH INVESTMENT IDEA 02 JUNE 2017

Credit Analysis and Research

Private Client Group - PCG RESEARCH P a g e | 1

Industry CMP Recommendation Add on Dips to band Target Time Horizon

Financial Services Rs 1450 BUY Rs 1310 - 1450 Rs 1645-1835 3-4 Quarters

HDFC Scrip Code CREANA

BSE Code 534804

NSE Code CARERATING

Bloomberg CARE

CMP as on 2 Jun 17 1450

Equity Capital (Rs Cr)

29.45

Face Value (Rs) 10

Equity O/S (Cr) 2.95

Market Cap (Rs Cr) 4,271

Book Value (Rs) 168

Avg. 52 Week Volumes

76338

52 Week High 1695

52 Week Low 956

Shareholding Pattern (%)

Promoters 00

Institutions 80

Non Institutions 20

PCG Risk Rating* Yellow * Refer Rating explanation

Nisha Sankhala [email protected]

Credit Analysis and Research Limited is one of the leading players in credit rating space. The Company is

engaged in providing financial services other than securities dealing activities. The Company's segments include

Ratings and related services, and Others that offers a wide range of rating and grading services across sectors.

CARE has commenced operations in April 1993 and in nearly two & a half decades time, it has established itself

as the second-largest credit rating agency in India in terms of rating income. The company has rated a large

volume of debt of around Rs. 78.81 lakh Cr and has completed 46,881 rating assignments since its inception to

FY16.

In the last few years, the company has begun expanding internationally also and is providing technical

assistance services to countries like Maldives, Hong Kong, Nepal and Mauritius.

INVESTMENT RATIONALE:

The Indian economy is expected to progress at a faster rate in the coming years. Factors like Normal Monsoon,

GST & other structural reforms, stable Monetary policy, Bad loan resolution etc. will boost the Economy and

which in turn would make need for higher levels of funding that would provide a boost to the debt and credit

markets. This will bring more and more opportunities for CARE.

The ratings business is driven by regulatory requirements or requires accreditation, recognition or approval

from government authorities. In recent past, the two major reforms by Government like Insolvency and

Bankruptcy Code and RBI's Bond Market reforms have proved blessings for CARE.

The Balance Sheet position of the company remains quite healthy. CARE is a Zero debt company with cash &

equivalents on the books at ~ Rs 369 Cr which it may use to give dividends to its shareholders or through

buyback offer.

The Return Ratios (RoE and RoCE) of the company are robust at 32.6% and 42.1% respectively. And the

Dividend pay-out ratio of the company is at lucrative levels of 56% in FY17P.

Among the Ratings players, CARE remains margin leader with EBITDA Margin at 63.5% in FY17 and in the past

also company has sustained the same around those levels. PAT Margin for FY17P was very high at 51.3%.

The company is continuously developing new product avenue and market for grow accelerations.

mailto:[email protected]

PCG RESEARCH


View & Valuation:

In FY17, consolidated Net sales posted just 3% YoY growth to Rs. 320 Cr from Rs 288 Cr in FY16. This was

mainly due to economic slowdown. While Net Profit surged 23.5% to Rs 148 Cr on account of higher

operating margin as high as 63.5%. The company has been share holder Friendly as it has maintained

dividend pay-out at >50% for the past several years. In Sep 2014, company had paid onetime special

dividend of Rs 65 per equity share. Going forward, we expect top line and bottom line to post 12.7% and

14.5% CAGR respectively over FY17-19E. We forecast EBITDA to show 15.7% CAGR over the same period.

We have estimated 180bps margin expansion on the back of cost optimization measures and turnaround

from subsidiaries. We initiate coverage with Buy rating on CARE and value the stock at 28x FY19E EPS. Our

price target of Rs 1835 implies 29% upside potential from current levels. We recommend investors to buy

the stock at CMP of Rs 1450 and add on dips to Rs 1310 for the sequential targets of Rs. 1645 and Rs 1835

over the next 12 months.

Risk & Concerns:

Economic Risk: The rating business is majorly dependent on the macro Economy and capex cycle

of the country. So any slowdown in economic growth may adversely affect the Company’s

performance.

Competition: The credit rating and financial services markets are constantly evolving and the

market for such services is becoming increasingly competitive. CARE faces pricing pressure from its

competitors.

Regulatory risk: The ratings business is driven by regulatory requirements or requires

accreditation, recognition or approval from government authorities. In the event of any change to

these regulations or norms, there may be decrease or increase in the demand for ratings.

Concentration risk: According to FY17P ~98% revenues has been generated from only rating

segment while the balance were from other business. Any slowdown in the growth of rating industry

may also become hurdle for the growth of CARE also.

PCG RESEARCH


BUSINESS BACKGROUND:

Credit Analysis & Research Ltd (CARE) is full service rating company that offers a wide range of rating and

grading services across sectors. CARE has commenced operations in April 1993 and in nearly two & a half

decades time, it has established itself as the second-largest credit rating agency in India in terms of rating

income. The company has rated a large volume of debt of around Rs. 78.81 lakh Cr and has completed

46,881 rating assignments since its inception to FY16.

In the last few years, the company has begun expanding internationally also and is providing technical

assistance services to countries like Maldives, Hong Kong, Nepal and Mauritius.

CARE Ratings provides the entire spectrum of credit rating that helps the corporates to raise capital for their

various requirements and assists the investors to form an informed investment decision based on the credit

risk and their own risk-return expectations. It has also emerged as the leading agency for covering many

rating segments like that for banks, sub-sovereigns and IPO grading.

Unlike other rating companies like ICRA (~40% from rating) and CRISIL (~60% from rating), Almost entire

revenue of CARE comes from rating business. According to FY17P numbers ~98% Business has been

generated from only rating segment while the balance from business like Sales of publications, License fees

and Advisory Services.

CARE has consistently Gained Market Share….

51 50 49 51 53 51 50 48

24 22 22 22 20 20 21 22

25 28 29 28 27 28 29 30

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Crisil (Ratings business) ICRA CARE

Source: Company, HDFC sec Research

% Market Share

PCG RESEARCH


INVESTMENT RATIONALE:

Economy growth and Capex Cycle:

Industry Background

The credit rating business is quite unique as it depends on two extraneous developments. First there has to

be spark in the economy as all business activity depends on the economic progress. Second for rating is of

debt instruments, there has to be higher level of borrowings in the market, as rating agencies can rate as

much as that enters the market.

Current Situation of Industry

Given that CARE rates a large and diverse set of entities, the movement of MCR can be regarded as being

indicative of the general business and economic environment of the country.

Credit Quality of domestic rated firms/entities declined during FY17 as indicated by the MCR - Modified Credit

Ratio. Although the ratio continues to be above unity, indicating higher number of upgrades than

downgrades, there has been moderation in the ratio during this fiscal year to 1.04 compared with the 1.13 in

FY16 and 1.17 in FY15.

The rating business has failed to impress in FY17 because of Demonetization and lower Credit Growth in the

economy. The overall economy grew at the rate of ~7.1% in FY17 from ~7.6% growth in FY16. The Credit

growth of the country has also plunged 63-year low level of 5.08% in fiscal 2017. In this environment also

CARE has managed to grow at ~3% top line and 23.5% bottom-line.

MCR - Modified Credit Ratio


PCG RESEARCH


The Indian economy is expected to progress at a faster rate in coming years. Factors like Normal Monsoon,

GST & other structural reforms, stable Monetary policy, Bad loan resolution etc will boost the Economic and

which in turn would make need for higher levels of funding that would provide a boost to the debt and credit

markets. This will bring more and more opportunities for CARE.

Regulatory reforms Blessings in Disguise:

The ratings business is driven by regulatory requirements or requires accreditation, recognition or approval

from government authorities. In the event of any change to these regulations or norms, there may be a

decrease or increase in the demand for ratings. The same has happened in recent past, the 2 major reforms

by Government has proved blessings for CARE Rating:

Insolvency and Bankruptcy Code: Indian Bond market is highly dominated by high rated securities

like AAA & AA+ and hardly any activities happens in lower rated securities. So with Insolvency and

Bankruptcy Code coming in, some traction has been observed in lower rated securities and going

ahead also we believe a considerable change this section.

RBI's Bond Market reforms: Earlier, companies that earned a rating of BB and below were given a

150% risk weight. It was found that there were too many entities to be rated and it is difficult to

cover all of them as a result of which the unrated entities were kept at 100% risk weight. This created

an incentive for borrowers to remain weak borrowers so as to remain unrated as such. The risk

weights are now being aligned with the following changes.

1. With effect from 30 June 2017, all unrated claims on corporates, Asset Finance Companies or AFCs,

and NBFC-IFCs having aggregate exposure from the banking system of more than Rs2bn will attract a

risk weight of 150%.

2. However, claims on corporates, AFCs, and NBFC-IFCs having aggregate exposure from the banking

system of more than Rs 1bn which were rated earlier but have subsequently become unrated, will

attract a risk weight of 150% with immediate effect.

SME segment - A Helping Hand:

The SME rating is one of the fastest growing elements in the credit rating space. And when we talk about

CARE, it is still at a very nascent stage as very negligible revenues come from SME business. This segment is

currently dominated by CRISIL and SMERA. Company had been building the infrastructure for gaining market

share in this segment. SME rating contribution in overall revenue improved from 6% in FY16 to 9% in FY17.

In future we expect this segment to augur well for the rating revenue of the company.

PCG RESEARCH


Robust Return Ratios and Healthy Balance Sheet:

The Return Ratios (RoE and RoCE) of the company were robust at 32.6% and 42.1% respectively. And the

Dividend pay-out ratio of the company is at lucrative levels of 56% in FY17P.

Going forward, we believe that the company has huge potential to improve these ratios further. This one

facet alone is sufficient to lure the investors in to owning a piece of the company.

As the business model is as such which does not requires big capex the company can distribute its profit to

shareholders in the form of Dividend. The Dividend pay-out ratio of the company is 56% in FY17P. This high

pay-out also makes CARE very lucrative for investment.

The Balance Sheet position remains healthy. CARE is almost Zero debt company further cash & equivalents

on the books are ~ Rs 369 Cr which it may use to give dividends to its shareholders or through buyback

offer.

Enjoys the best in class Margins in the industry

The Company has been generating excellent operating Cash flow because of the fact that it requires less/

negligible capex. Largely, it requires only expense the company has to incur for expanding business is higher

employee strength and some advertisement cost. All these bring higher margins for the company.

Robust Return ratios


PCG RESEARCH


Among the Ratings players, CARE remains margin leader with EBITDA Margin at 63.5% in FY17 and in the

past also company has sustained the same around those levels. PAT Margin for FY17P was very high at

51.3%.

New Developments:

The company is continuously developing new product avenue and market for grow accelerations. In recent

years also following developments has been done by company.

Launched the rating of Real Estate Investment Trusts (REITs).

Launched the New Credit Rating system for infrastructure projects.

The African Development Bank (AFDB) infused USD 39,999 for 9.99% stake in CARE Ratings (Africa)

Private Limited (CRAF).

CARE Advisory Research & Training Ltd (CART) got incorporated.

Wholly-owned subsidiary of Credit Analysis & Research Ltd. (CARE).

CART has been formed with the objective of rendering financial and management advisory

services, undertaking diligence studies and appraisals of all types of projects and other

related research.

Stellar Margins on the back of low cost business model


PCG RESEARCH


Company had signed MoU with Vishal Group Limited and Emerging Nepal Limited to start credit rating

agency in Nepal to be called CARE Ratings (Nepal) Limited

Financial Highlights and Future Estimates:

In FY17P consolidated Net sales posted just 3% YoY growth to Rs. 320 Cr from Rs 288 Cr in FY16. This was

mainly due to economic slowdown. While Net Profit grew only 23.5% to Rs 148 Cr on account of higher

operating margin as high as 63.5%. Going forward, we expect top line and bottom line to post 12.7% and

14.5% CAGR respectively over FY17-19E. We forecast EBITDA to show 15.7% CAGR over the same period.

We have estimated 180bps margin expansion on the back of cost optimization measures and turnaround

from subsidiaries. We recommend investors to buy the stock at CMP of Rs 1450 and add on dips to Rs 1310

for the sequential targets of Rs. 1645 and Rs 1835 over the next 12 months.

Number of assignments done by CARE


Number of Active clients of CARE


PCG RESEARCH


FY17P Revenue Split (%)


Revenue to post ~10% CAGR in FY16-FY19E


EBITDA & EBITDA Margin Trend


Dividend (Rs / Share)


FY15 One Time Special Dividend

PCG RESEARCH


Income Statement (Consolidated)

(Rs Cr) FY15 FY16 FY17P FY18E FY19E

Net Revenue 261 279 287 320 365

Other Income 43.7 8.7 33.0 41.0 50.0

Total Income 304 288 320 361 415

Growth (%) 10.6 7.2 2.9 11.5 14.0

Operating Expenses 101.0 105.5 104.8 114.6 126.9

EBITDA 203.3 182.6 215.6 246.9 288.5

Growth (%) 8.0 9.0 5.0 12.7 15.8

EBITDA Margin (%) 61.2 62.2 63.5 64.2 65.3

Depreciation 5.1 4.2 3.4 3.9 4.2

EBIT 198 178 212 243 284

Interest 1.3 0.0 0.0 0.0 0.0

PBT 197 178 212 243 284

Tax 59.1 58.8 64.7 76.5 89.5

RPAT 138 120 148 165 193

Growth (%) 6.3 -13.3 23.5 12.8 17.0

EPS 47.5 41.1 50.0 56.2 65.7 Source: Company, HDFC sec Research

Balance Sheet (Consolidated) As at March FY15 FY16 FY17P FY18E FY19E

SOURCE OF FUNDS

Share Capital 29.0 29.4 29.4 29.4 29.4

Reserves 330 379 466 523 584

Shareholders' Funds 359 409 495 553 613

Long Term Debt 0.0 0.0 0.0 0.0 0.0

Net Deferred Taxes 2.9 2.6 3.9 3.9 3.9

Long Term Provisions & Others 5.3 5.7 4.0 4.0 4.0

Minority Interest 0.0 0.0 0.5 0.0 0.0

Total Source of Funds 367 417 504 561 621

APPLICATION OF FUNDS

Net Block 57 56 53 54 57

Deferred Tax Assets (net) 0.0 0.3 0.3 0.3 0.3

Long Term Loans & Advances 205.2 238.0 97.7 119.0 130.7

Total Non-Current Assets 262 294 151 173 188

Current Investments 148.8 160.2 354.7 379.5 421.2

Inventories 0.0 0.0 0.0 0.0 0.0

Trade Receivables 15.7 23.6 25.3 26.3 30.0

Short term Loans & Advances 2.4 4.8 4.2 5.5 7.4

Cash & Equivalents 14.8 12.8 14.1 28.0 35.0

Other Current Assets 1.8 7.3 3.6 5.4 9.3

Total Current Assets 184 209 402 445 503

Short-Term Borrowings 0.0 0.0 0.0 0.0 0.0

Trade Payables 0.0 1.0 0.5 0.6 0.7

Other Current Liab & Provisions 39.0 36.9 38.9 44.3 51.8

Short-Term Provisions 39.3 47.9 10.0 12.5 17.5

Total Current Liabilities 78.3 85.8 49.4 57.4 70.0

Net Current Assets 105.3 122.9 352.5 387.3 432.8

Total Application of Funds 367 417 503 561 621 Source: Company, HDFC sec Research

PCG RESEARCH


Cash Flow (Consolidated)


Reported PBT 196.9 178.4 212.3 243.0 284.3

Non-operating & EO items -44.2 15.2 2.3 -41.0 -50.0

Interest Expenses 1.3 0.0 0.0 0.0 0.0

Depreciation 5.1 4.2 3.4 3.9 4.2

Working Capital Change 112.9 -19.7 -228.2 -20.9 -38.6

Tax Paid -59.1 -58.8 -64.7 -76.5 -89.5

OPERATING CASH FLOW ( a ) 212.8 119.2 -75.1 108.5 110.4

Capex -10.8 -2.5 -0.8 -5.0 -7.0

Free Cash Flow 202.1 116.7 -75.9 103.5 103.4

Investments 5.5 -33.1 140.3 -21.3 -11.7

Non-operating income 43.7 8.7 33.0 41.0 50.0

INVESTING CASH FLOW ( b ) 38.4 -26.9 172.6 14.7 31.3

Debt Issuance / (Repaid) 0.2 0.0 -0.3 0.0 0.0

Interest Expenses -1.3 0.0 0.0 0.0 0.0

FCFE 201.0 116.7 -76.2 103.5 103.4

Share Capital Issuance -0.9 0.4 0.5 -0.5 0.0

Dividend -263.1 -94.7 -96.3 -108.8 -134.7

FINANCING CASH FLOW ( c ) -265.1 -94.3 -96.2 -109.3 -134.7

NET CASH FLOW (a+b+c) -13.9 -2.0 1.3 13.9 7.0 Source: Company, HDFC sec Research

Key Ratios


EBITDA Margin 61.2 62.2 63.5 64.2 65.3

EBIT Margin 76.1 63.9 73.8 75.8 77.8

APAT Margin 52.9 42.8 51.3 51.9 53.3

RoE 32.6 31.1 32.6 31.5 33.2

RoCE 54.0 42.8 42.1 43.3 45.8

Solvency Ratio

Net Debt/EBITDA (x) -1.0 -1.0 -2.0 -2.0 -1.9

D/E 0.0 0.0 0.0 0.0 0.0

Net D/E -0.5 -0.4 -0.7 -0.7 -0.7

PER SHARE DATA

EPS 47.5 41.1 50.0 56.2 65.7

CEPS 49.3 42.1 51.2 57.5 67.2

BV 123.8 139.0 168.4 188.0 208.5

Dividend 79.0 28.0 28.0 32.0 39.0

Turnover Ratios (days)

Debtor days 22.0 30.8 30.0 30.0 30.0

Creditors days 0.0 3.5 0.0 2.0 2.0

VALUATION

P/E 30.5 35.3 29.0 25.8 22.1

P/BV 11.7 10.4 8.6 7.7 7.0

EV/EBITDA 28.1 25.7 24.5 21.7 18.8

EV / Revenues 17.2 16.0 15.6 14.0 12.3

Dividend Yield (%) 5.4 1.9 1.9 2.2 2.7

Dividend Payout 166.2 68.1 56.0 56.9 59.3 Source: Company, HDFC sec Research

PCG RESEARCH


Rating Chart

R E T U R N

HIGH

MEDIUM

LOW

LOW MEDIUM HIGH

RISK

Ratings Explanation:

RATING Risk - Return BEAR CASE BASE CASE BULL CASE

BLUE LOW RISK - LOW RETURN STOCKS

IF RISKS MANIFEST PRICE CAN FALL 20% OR MORE

IF RISKS MANIFEST PRICE CAN FALL 15%

& IF INVESTMENT RATIONALE

FRUCTFIES PRICE CAN RISE BY 15%

IF INVESTMENT RATIONALE

FRUCTFIES PRICE CAN RISE BY 20% OR

MORE

YELLOW MEDIUM RISK - HIGH RETURN STOCKS






FRUCTFIES PRICE CAN RISE BY 35% OR

MORE

RED HIGH RISK - HIGH RETURN STOCKS







OR MORE

PCG RESEARCH


Rating Definition:

Buy: Stock is expected to gain by 10% or more in the next 1 Year. Sell: Stock is expected to decline by 10% or more in the next 1 Year.

PCG RESEARCH


Disclosure: I, Nisha Sankhala, MBA, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Further Research Analyst or his relative or HDFC Securities Ltd. or its associate does not have any material conflict of interest. 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RESEARCH Credit Analysis and Research PCG... · growth of the country has also plunged 63-year low...

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Transcript of RESEARCH Credit Analysis and Research PCG... · growth of the country has also plunged 63-year low...